One source of cash savings for a company is improved management of inventory. To illustrate, assume that Best Buy and Circuit City both have $300,000 per month in sales in the Virginia area, and both forecast this level of sales per month for the next 24 months. Also assume that both Best Buy and Circuit City 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 Best Buy and Circuit City is the distribution system. Best Buy 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, Circuit City 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 Circuit City can reduce its inventory level if it can match Best Buy’s system of maintaining an inventory equal to 10% of next month’s sales.
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.