Question

xyz Ltd is a UK-based manufacturing company. prepare an analysis.

xyz Ltd has credit sales of £45 million per year and on average settles accounts with trade payables after 60 days. One of its suppliers has offered the company an early settlement discount of 0.5% for payment within 30 days. Administration costs will be increased by £500 per year if the early settlement discount is taken. xyz Ltd buys components worth £1.5 million per year from this supplier.

From a different supplier, xyz Ltd purchases £2.4 million per year of Component C at a price of £5 per component. Component C is assumed to be consumed at a constant rate throughout the year. The company orders components at the start of each month in order to meet the demand and the cost of placing each order is £248.44. The holding cost for Component C is £1.06 per unit per year.

The finance director of xyz Ltd is concerned that approximately 1% of credit sales turn into irrecoverable debts. In addition, he has been advised that customers of the company take an average of 65 days to settle their accounts, even though xyz Ltd requires settlement within 40 days.

xyz Ltd finances working capital from an overdraft costing 4% per year.

Assume there are 360 days in a year.

Required:

1. (a) Evaluate whether xyz Ltd should accept the early settlement discount offered by its supplier.

2. (b) Adopting an economic order quantity (EOQ) approach, calculate the total cost of EOQ ordering policy for Component C.