Exhibit 28.3
Assume that Palmer Executive Pens uses 1,440,000 gallons of ink each year. Further, assume that Palmer can order the ink at a cost of $2 per gallon plus fixed ordering costs of $100 per order. The firm's carrying cost is 20 percent of the inventory value, at cost.
-Refer to Exhibit 28.3.Now,suppose the manufacturer offers a discount of 0.5 percent for orders of a least 40,000 gallons.Should Palmer increase its ordering quantity to take the discount?

Question

Quizplus · Accepted Answer

To determine whether Palmer should take advantage of the discount, we need to calculate the total cost of ordering 40,000 gallons with the discount versus the total cost of ordering the regular amount of 1,440,000 gallons.

Ordering 40,000 gallons would result in 36 orders: 1,440,000/40,000 = 36

The cost of ordering 40,000 gallons with the discount is:

Gallons ordered: 40,000
Cost per gallon: $2 - 0.5% discount = $1.99
Total cost of ink: 40,000 x $1.99 = $79,600
Ordering cost: $100 x 36 = $3,600
Carrying cost: 20% x ($79,600 + $100 x 36) = $16,752
Total cost: $79,600 + $3,600 + $16,752 = $99,952

The cost of ordering 1,440,000 gallons without the discount is:

Gallons ordered: 1,440,000
Cost per gallon: $2
Total cost of ink: 1,440,000 x $2 = $2,880,000
Ordering cost: $100
Carrying cost: 20% x $2,880,000 = $576,000
Total cost: $2,880,000 + $100 + $576,000 = $3,456,100

Therefore, ordering 40,000 gallons with the discount results in a total cost of $99,952, while ordering 1,440,000 gallons without the discount results in a total cost of $3,456,100. The difference in cost is $3,456,100 - $99,952 = $3,356,148.

Since ordering 40,000 gallons with the discount results in a much lower cost, Palmer should increase its ordering quantity to take advantage of the discount. The amount saved is $3,356,148 - ($576,000 - $16,752) = $3,792,900, which translates to $3,792,900/36 = $105,358 per order. Thus, the amount saved per order is $105,358 - $100 - $1.99 x 40,000 = $13,573, which is closest to answer choice D.

Exhibit 28.3 Assume That Palmer Executive Pens Uses 1,440,000 Gallons of Ink