WHICH SENARIO IS CORRECT PERTAINING TO JUST-IN-TIME INVENTORY PAYABLE AND WHY??? OPTION #1 OR OPTION #2?

Roberts , Inc. is a medical equipment dealer selling to doctors, hospitals, and other medical providers. The company has historically been profitable, but is presently having cash flow problems.

The firm is evaluating the sales forecast for the upcoming year for one of Roberts products, mobile ultrasound imaging units. Roberts forecasts 27,000 units will be sold in the upcoming year (evenly distributed across the year).

INVENTORY PURCHASES AND ACCOUNTS PAYABLE

Roberts supplier for this product recently introduced an aggressive quantity discount program. If Roberts agrees to order 1,000 machines at a time, the price will drop by 1% from the regular price of $26,800/unit. Roberts presently orders 500 units at a time, or 54 times a year (27,000/500). They estimate that ordering costs are $615/order and holding costs are $350/unit based on average inventory.

The supplier offers 45 day credit terms. While not new, the supplier will begin enforcing the 22% fee for late payors. Presently, even though the terms are net 45, Roberts DPO averages 85 days. If Roberts does not select the quantity discount program, it will continue to be offered net 45 terms. However, it will now be assessed the late fee.

CREDIT TERMS AND ACCOUNTS RECEIVABLE

Roberts sells the machines to its customers for $37,200. Roberts sells to customers on 30 day terms. DSO generally runs 48 days. Roberts does not aggressively manage collections, fearful that it will lose customers. A major competitor recently introduced 2/10, net 50 terms. If Roberts matches the competition, it estimates that 40% of its customers would take advantage of the discount. Those not taking the discount will likely slow to 58 days. Roberts would offer the discount to protect existing sales, but does not expect sales growth from the new credit policy. It believes if it doesnt offer the discount that sales will decrease by 3%.

ANALYSIS

To calculate value, Roberts uses a required rate of return of 18%. Management wants to evaluate four combinations of inventory order quantity, A/P terms, and A/R terms that impact cash flows and the timing of cash flows. To determine the optimal combination, the highest NPV over the upcoming 360-day year will be selected. NPV is calculated by (1) calculating the PV of the cash inflows from sales (A/R), (2) subtracting the PV of the outflows related to the inventory (holding and ordering costs), and (3) subtracting the PV of the outflows related to purchasing decisions (A/P).

The NPV from the present structure (modified for the late fee and expected loss in sales) will be compared to the four options below:

Case 1

New A/R terms

Old A/P terms (paying in 85 days with late fee)

Current inventory quantity

Case 2

New A/R terms

Old A/P terms (paying on time in 45 days)

Current inventory quantity

Case 3

New A/R terms

New A/P terms (paying on time in 45 days)

Higher inventory quantity with quantity discount

Case 4

New A/R terms

New A/P terms (paying in 85 days with late fee)

Higher inventory quantity with quantity discount

To determine the outcome for the various options, use Excel to perform the calculations. Which option should Roberts choose? Why?

***************JUST-IN-TIME*********************************

After completing the preliminary analysis, another option is considered a Just In Time (JIT) Inventory System. Here, if Roberts can plan ahead and estimate its need for the upcoming year, the supplier can ship units on a daily basis, eliminating the accumulation of inventory. If Roberts adopted JIT, the order quantity would be only 75 units per order (27,000/360). Given the standing order, ordering costs would shrink to just $105/order and holding costs would be eliminated. With JIT, Roberts will pay cash for all orders with the 22% late fee, but is offered no discount. A drawback is that Roberts must commit to buy the inventory in advance, regardless of sales demand. To compensate for this risk, it will use a 25% opportunity cost for this option. Roberts would continue to offer the new A/R terms.

OPTION #1:

	Present	Case 1	Case 2	Case 3	Case 4	JIT
INVENTORY
Order Costs (per order) (F)	$ 615	$ 615	$ 615	$ 615	$ 615	$ 105
Holding Costs (per unit) (H)	$ 350	$ 350	$ 350	$ 350	$ 350	$ -
Unit Cost (C')	$ 26,800	$ 26,800	$ 26,800	$ 26,800	$ 26,800	$ 26,800
Inventory Order Quantity (Q)	500	500	500	1,000	1,000	75
PAYABLES
Credit Period (Terms)	45	45	45	45	45	45
Payment Period (CP)	85	85	45	45	85	85
Quantity Discount	0%	0%	0%	1%	1%	0%
Daily Late Fee (22%/year)	0.0611%	0.0611%	0.0611%	0.0611%	0.0611%	0.0611%
SALES / RECEIVABLES
Base Sales (# units sold)	27,000	27,000	27,000	27,000	27,000	27,000
Selling Price (per unit)	$ 37,200	$ 37,200	$ 37,200	$ 37,200	$ 37,200	$ 37,200
Sales Growth Rate (g)	-3%	0%	0%	0%	0%	0%
Credit Period (Terms)	30	50	50	50	50	50
DSO (non-discount customers)	48	58	58	58	58	58
Discount Period (DP)	-	10	10	10	10	10
Discount (d)	0%	2%	2%	2%	2%	2%
Percent Taking Discount (p)	0%	40%	40%	40%	40%	40%
GENERAL
Opportunity Cost (k)	18%	18%	18%	18%	18%	25%
Base Period (days)	360	360	360	360	360	360
NPV ANALYSIS
+ PV Cash Flow From A/R	$ 876,280,056	$ 921,133,862	$ 921,133,862	$ 921,133,862	$ 921,133,862	$ 896,234,925
- PV Cash Flow Inventory Cost	$ 101,775	$ 102,297	$ 102,297	$ 162,377	$ 162,377	$ 30,240
- PV Cash Flow From A/P	$ 644,200,034	$ 656,912,518	$ 652,833,326	$ 647,278,955	$ 651,305,959	$ 628,600,482
= NPV	$ 231,978,247	$ 264,119,047	$ 268,198,239	$ 273,692,530	$ 269,665,526	$ 267,604,203

OPTION #2:

	Present	Case 1	Case 2	Case 3	Case 4	JIT
INVENTORY
Order Costs (per order) (F)	$ 615	$ 615	$ 615	$ 615	$ 615	$ 105
Holding Costs (per unit) (H)	$ 350	$ 350	$ 350	$ 350	$ 350	$ -
Unit Cost (C')	$ 26,800	$ 26,800	$ 26,800	$ 26,800	$ 26,800	$ 26,800
Inventory Order Quantity (Q)	500	500	500	1,000	1,000	75
PAYABLES
Credit Period (Terms)	45	45	45	45	45	0
Payment Period (CP)	85	85	45	45	85	0
Quantity Discount	0%	0%	0%	1%	1%	0%
Daily Late Fee (22%/year)	0.0611%	0.0611%	0.0611%	0.0611%	0.0611%	0.0611%
SALES / RECEIVABLES
Base Sales (# units sold)	27,000	27,000	27,000	27,000	27,000	27,000
Selling Price (per unit)	$ 37,200	$ 37,200	$ 37,200	$ 37,200	$ 37,200	$ 37,200
Sales Growth Rate (g)	-3%	0%	0%	0%	0%	0%
Credit Period (Terms)	30	50	50	50	50	50
DSO (non-discount customers)	48	58	58	58	58	58
Discount Period (DP)	-	10	10	10	10	10
Discount (d)	0%	2%	2%	2%	2%	2%
Percent Taking Discount (p)	0%	40%	40%	40%	40%	40%
GENERAL
Opportunity Cost (k)	18%	18%	18%	18%	18%	25%
Base Period (days)	360	360	360	360	360	360
NPV ANALYSIS
+ PV Cash Flow From A/R	$ 876,280,056	$ 921,133,862	$ 921,133,862	$ 921,133,862	$ 921,133,862	$ 896,234,925
- PV Cash Flow Inventory Cost	$ 101,775	$ 102,297	$ 102,297	$ 162,377	$ 162,377	$ 30,240
- PV Cash Flow From A/P	$ 644,200,034	$ 656,912,518	$ 652,833,326	$ 647,278,955	$ 651,305,959	$ 646,067,737
= NPV	$ 231,978,247	$ 264,119,047	$ 268,198,239	$ 273,692,530	$ 269,665,526	$ 250,136,948