Question: One source of cash savings for a company is improved management of inventory. To illustrate, assume that Research In Motion and Apple both have $200,000 per month in sales of one model of handheld devices in Canada, and both forecast this level of sales per month for the next 24 months. Also assume that both Research In Motion and Apple have a 20% contribution margin and equal fixed costs, and that cost of goods sold is the only variable cost. Assume that the main difference between Research In Motion and Apple is the distribution system. Research In Motion uses a just-in-time system and requires ending inventory of only 10% of next month's sales in inventory at each month-end. However, Apple is building an improved distribution system and currently requires 40% of next month's sales in inventory at each month-end.
Required: 1. Compute the amount by which Apple can reduce its inventory level if it can match Research In Motion's system of maintaining an inventory equal to 10% of next month's sales. (Hint: Focus on the facts given and only on the Canada area.)
2. Explain how the analysis in part 1 that shows ending inventory levels for both the 40% and 10% required inventory policies can help justify a just-in-time inventory system. You can assume a 15% interest cost for resources that are tied up in ending inventory.