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Amol Srivastava, Accountant

Category: Finance

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Experience: More than 4years + of industry experience ,CFA level2 cleared, Chartered Accountant from India

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A mining company requires sticks of dynamite at the rate of

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A mining company requires sticks of dynamite at the rate of 2,500 sticks per month. Three suppliers are ready to supply. The ordering costs in all three cases are 240 pounds per order and the current interest rate is 20 % per annum. The following details are available:

Supplier X: Price per stick of dynamite: 3.36 pounds
Minimum order quantity: 1000 sticks
Sticks which are defective: four % per batch supplied on average.

Supplier Y: price per stick of dynamite: 3.30 pounds
No minimum order quantity specified
Because of unreliable supply, a safety stock of 2,000 sticks to be kept in the mining company at all times.

Supplier Z: Price per stick of dynamite: 3.20 pounds
Fixed charge per order of 1.250 pounds in addition of the price of the sticks.

Evaluate each of the three suppliers and determine which one the mining company should choose. Give reasons for your choice

We have to make some assumptions in solving this question. They are stated with each supplier: 1.Assumed that all the orders are place at the start of the month.So ffrom supplier one 3 orders of 1000 sticks each are placed. Not defective sticks will be 2880 of which 2500 will be used and an inventory of 380 will be placed on which an interest will be placed @ 20%. so final cost 2500*3.36+380*3.36*1/12*.20 = 8421.28

2.An amount equivalent to cost of 2000 sticks have to be kept in inventory at all times so there will be interest cost associated with that.Hence the final cost will be : 2500*3.3+2000*3.3*1/12*.20 = 8360

3.I assumed the fixed charge is 1,250 so the calculation is : 3.2*2500+1250= 9250

Thus supplier 2 is the best. In all these costs the ordering cost of 240 will be the same hence it is not considered.

1.In the first option in every shipment company receives 4% are defective. So in every 1000 company receive working ones are only 960. Now company have a monthly requirement of 2500 sticks so it has to order 3 shipments. Company will receive 960*3=2880 sticks as result. Now the company needs only 2500 out of 2880 so the remaining 380 it has to keep as inventory and for maintaining inventory it has to take loan @20%pa.

Moreover company pays for 1000 sticks although working ones are only 960 per shipment.Hence per stick cost is 1000*3.6/960 = 3.5

So the cost now works out to:

Cost of 2500 sticks - 2500*3.5 =8750

Interest cost for inventory of 380. - 380*3.5*.20*1/12=22.17

Total cost in option 1 = 8772.17

2.Since the second supplier is not a reliable one hence we have to maintain a stock of 2000 sticks. Again for maintaining this stock we need loan @20 % pa. There is no miminum order so we can order as much as we want so we will order only 2500 sticks in addition to 2000 sticks we need to keep in inventory The cost works out to be :

Cost of 2500 sticks - 2500*3.3 = 8250 Interest cost - 2000*3.3*1/12*.20=110 Total cost = 8360

3.Not lets come to option 3. There are no conditions in option three and per unit cost of sticks is also lowest but supplier 3 charges a fixed charge of 1250.So the cost works out to be : Cost of 2500 sticks - 2500*3.2 = 8000 Fixed cost - 1250 Total cost = 9250

Thus although second supplier is the most unreliable one but still he has to be chosen because total cost is lowest in his case. Let me know if you need more details.

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