You work for a firm of management consultants that offers assistance to new businesses. One of your clients is Shorttress Manufacturing, a company that manufactures a small, but vital, component for the specialized lighting industry. Shorttress is a new company (and a new client for your employer) and you have been assigned the task of advising them of their options for financing their inventory during the first few months.
The marketing experts have told you that the company should have at least three months of inventory on hand so it can meet all demands from Shorttress's customers.
The annual production of the Shorttress component is projected to be 120,000 units. Annual direct labour and direct material costs together are estimated at $300,000 per year. Variable manufacturing costs are estimated to be $180,000 per year; fixed manufacturing costs are projected to be $500,000 per year. Fixed marketing and administration costs are estimated at $700,000 per year. These projections are all for the company's first year of business.
Instructions
(a) Assuming that Shorttress must hold three months of the component in inventory, what is the cost of the three-month inventory using variable costing? What is the cost of inventory using absorption costing?
(b) Shorttress's bankers have advised their client that bank financing will only cover 50% of the inventory's cost. What alternative strategies can you suggest to Shorttress to help it deal with this funding shortfall?