Question

How might the cost of a stockou Deu 12. Assume an organizations me an organization's current service level on order fill is as follo Current order fill = 80% Number of orders per year = 5,000 Percentage of unfilled orders back-ordered = 70% Percentage of unfilled orders cancelled = 30% Back order costs per order = $150 Lost pretax profit per cancelled order = $12,500 a. What is the lost cash flow to the seller at this 80 percent service level? b. What would be the resulting increase in cash flow if the seller improved ord to 92 percent? C. If the seller invested $2 million to produce this increased service level, wou investment be justified financially? proved order fil service level, would the

Answer 1

Ans

Given Information

Current Order fill = 80%

No. of order per year = 5,000

Percent of unfilled orders back-ordered = 70%

Percent of unfilled orders cancelled = 30%

Back order costs per order = $150

Lost pretax profit per cancelled order = $12,500

a) Calculation of lost cash flows to the seller at 80% service level

The formula to calculate lost cash flows is

Cash flow = (Number of incomplete orders x Back order% x Back order cost per order) + (Number of incomplete orders x cancelled% x lost pretax profit per order)

No. of incomplete order = No. of order per tear * (1- order fill rate ) =  5000 * (1- 0.8) = 5000 * 0.2 = 1000

By putting values in formula

Lost Cash flow = ( 1000 * 70% * $150) + ( 1000 * 30% * $12,500)

= (700 * $ 150) + (300 * $12,500)

=$ 105,000 + $ 3,750,000

= $ 3,855,000

The sellers lost cash flow is $ 3,855,000 at 80% service level.

b) Calculation of increase in cash flow if the seller improved order fill to 92 percent.

No. of incomplete order = No. of order per tear * (1- order fill rate ) =  5000 * (1- 0.92) = 5000 * 0.08 = 400

Cash flow = (Number of incomplete orders x Back order% x Back order cost per order) + (Number of incomplete orders x cancelled% x lost pretax profit per order)

By putting values in formula

Lost Cash flow = ( 400 * 70% * $150) + ( 400 * 30% * $12,500)

= (280 * $ 150) + (120 * $12,500)

=$ 42,000 + $ 1,500,000

= $ 1,542,000

Cash flow lost at 92% service level is $ 1,542,000

Increase in cash flow due to increase in service level from 80% to 92%

Reduction in lost cash flow = Lost cash flow at 80% - Lost cash flow at 92%

= $ 3,855,000 - $ 1,542,000 = $ 2,313,000

Increase in cash flow by $ 2,313,000.

c)

If the seller invested $2 million to produce this increased service level, whether the investment is justified financially or not, we fill find it by calculating Return on Investment (ROI).

Return on Investment (ROI) =

Increased Return generated due to increased service level / Amount Invested to produce increased service level

= $ 2,313,000 / $2,000,000 = 115.65 %

Thus, the return is more than amount invested this investment is justified financially.