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Q 2.3 (Inventory Cost) A manufacturing company producing medical devices reported $60,000,000 in sales over the last year. At the end of the same year, the company had $20,000,000 worth of inventory of ready-to-ship devices. A. Assuming that units in inventory are valued (based on COGS) at $1,000 per unit and are sold for $2,000 per unit, how fast does the company turn its inventory? The company uses a 25 percent per year cost of inventory. That is, for the hypothetical case that one unit of $1,000 would sit exactly one year in inventory, the company charges its operations division a $250 inventory cost.

B. What—in absolute terms—is the per unit inventory cost for a product that costs $1,000?

Sales Inventory

$60,000,000 $20,000,000

Part A Selling Price COGS per Unit

$2,000 $1,000

Units Sold Total COGS

30,000 $30,000,000

Flow Time (in years)=Inventory/Flow rate Inventory Turns

(Flow)

(Flow Rate) (Flow Rate)

0.666667 1.5

Part B Per-Unit Inventory Cost Percentage Per-Unit Inventory Cost (in $)

16.66667 166.6667

Applying Little’s Law to Financials allows us to see how efficient organization is. 1

In this particular problem we're concerned with the process so that the average inflow ( going into the process ) and the average outflow (coming out of the process). How long does it take for a dollar to get through the entire process how many dollars are sitting in inventory and how many dollars go through the entire process in a period of time

Q 2.6 (Highway) While driving home for the holidays, you can't seem to get Little's Law out of your mind. You note that your average speed of travel is about 60 miles per hour. Moreover, the traffic report from the WXPN traffic chopper states that there is an average of 24 cars going in your direction on a one-quarter mile part of the highway. What is the flow rate of the highway (going in your direction) in cars per hour?

Speed (in MPH) Inventory Flow time for 1/4-mile stretch of highway (in hrs) Throughput (in cars per hour on highway) Throughput (in cars per minute on

60 24 0.00416 7 5760 96

highway)

This problem represents is an application of Little’s Law to transportation science. 

We look at 1 mile of highway as our process. Since the speed is 60 miles per hour, it takes a car 1 minute to travel through the process (flow time).



There are 24 cars on ¼ of a mile, i.e. there are 96 cars on the 1 mile stretch(inventory).



Inventory= Flow Rate * Flow Time: 96 cars=Flow Rate * 1 minute Thus, the Flow Rate is 96 cars per minute, corresponding to 96*60=5760 cars per hour.

Q2.9 (Major U.S. Retailers) The following table shows financial data (year 2004) for Costco Wholesale and Wal-Mart, two major U.S. retailers.

Assume that both companies have an average annual holding cost rate of 30 percent (i.e., it costs both retailers $3 to hold an item that they procured for $10 for one entire year). A. How many days, on average, does a product stay in Costco's inventory before it is sold? Assume that stores are operated 365 days a year. B. How much lower is, on average, the inventory cost for Costco compared to Wal-Mart of a household cleaner valued at $5 COGS? Assume that the unit cost of the household cleaner is the same for both companies and that the price and the inventory turns of an item are independent. Costco Inventories ($MM)

3643 3

Wal-Mart 29447

Sales (net $MM) COGS ($MM) (Flow Rate) Part A Flow Time (in days) Part B Per-Unit Inventory Cost Percentage Per-Unit Inventory Cost (in $)

48106 41651

286103 215493

31.92468

49.87705

2.623947

4.099484

0.131197

0.204974

Difference between inventory cost for $5 COGS item for the two companies:

0.073777

This problem is another example of Applying Little’s Law to Financial factors. In this case Little’s law enables us to compare the efficiency of two organizations. Also, this problem illustrates how one product behaves differently (in terms of costs) in each company.

Q2.10 (McDonald's) The following figures are taken from the 2003 1 financial statements of McDonald's and Wendy's. Figures are in million dollars.

a.

In 2003, what were McDonald's inventory turns? What

were Wendy's inventory turns?

b.

Suppose it costs both McDonald's and Wendy's $3

(COGS) per their value meal offerings, each sold at the same price of $4. Assume that the cost of inventory for both companies is 30 percent a year. Approximately how much does McDonald's save in inventory cost per value meal compared to that of Wendy's? You may assume the inventory turns are independent of the price.

Inventory Revenue

McDonald's 129.4 17140.5

Wendy's 54.4 3148.9

Cost of Goods Sold Gross Profit Part A Flow Time (in years) Inventory Turnover

11943.7 5196.8

1634.6 1514.4

0.01083416 92.3006182

0.03328 30.04779

Part B Per-Unit Inventory Cost 0.32502491 Percentage Per-Unit Inventory Cost (in 0.00975075 $) Difference between Wendy's and McDonald's inventory cost per value meal (in $): 

0.998409 0.029952 0.0202 02

Inventory turns for McDonald’s were 92.3. They were 30.05 for Wendy’s.



McDonald’s has per unit inventory costs of 0.32%, which for a 3$ meal about$0.00975. That compares to 0.998% at Wendy’s where the cost per meal is $0.0299

This problem allows us to compare the two restaurants in terms of efficiency affecting the length of time (flow) and inventory cost percentage. Again, this is an example of the application of Little’s Law to aid the process of company assessment with the intention of improvement.

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