Question

Howard's Comics, Inc. with annual sales of $9 million increases its inventory turnover from 4.0 to 5.0. How much would Howard's Comics, Inc. save annually in interest expense if the cost of carrying inventory is 4.5%?

		$45,000
		$15,500
		$5,000
		$20,250

Answer 1

Inventory turnover ratio = Annual sales / Average inventory

Existing Average inventory :

: 4 = $9,000,000 / Average inventory

: Average inventory = $9,000,000 / 4

: Average inventory = $2,250,000

Average inventory after increasing inventory turnover to 5 :

: 5 = $9,000,000 / Average inventory

: Average inventory = $9,000,000 / 5

: Average inventory = $1,800,000

Annual saving in interest expense incurred on carrying inventory :

: Reduction in average inventory x Cost of carrying inventory

: ($2,250,000 - $1,800,000) x 4.5% = $20,250