Problem
To reduce production start-up costs, Bodden Truck Company may manufacture longer runs of the same truck. Estimated savings from the increase in efficiency are $260,000 per year. However, inventory turnover will decrease from eight times a year to six times a year. Cost of goods sold is $48 million on an annual basis. If the required before-tax rate of return on investment in inventories is 15 percent, should the company instigate the new production plan? What is the opportunity cost?
Inventories after change = $48 million/6 = $8 million
Present inventories = $48 million/8 = $6 million Additional inventories = $2 million