You have heard so much about the just-in-time inventory concept that you have finally decided to investigate your current inventory system.
Assume a production period of 120 days. Your operation requires inventory of 5,000 units of inventory over that time period. Your current system is to place 4 orders of 1,250 units each. You order and receive the inventory on the same day along with the invoice. Invoice terms are net 15 days. Inventory costs $10 per unit and the order/setup costs are estimated to be $400 per order. Physical inventory holding costs average about $5 per unit over the production period of 120 days. Order/setup costs and holding costs are paid at the end of the production period. You wish to evaluate whether placing 8 orders of 625 results in a lower present value cost.
1. If the company's appropriate discount rate is 12 percent, calculate the present value cost of the current inventory policy.
2. Using the same discount rate, calculate the present value cost of the alternative inventory policy.
3. Which alternative do you recommend your company choose? Why?
4. Suppose that the alternative inventory policy would increase the chances of stocking out. What actions could you take to reduce that risk?
5. How would you revise your NPV analysis to incorporate those actions?