Question

2. The two suppliers in question offer different prices and different payment windows for the same part. We need to put the two options into the same terms by performing a price analysis.

• Supplier A: $100/unit, payment due in 90 days

• Supplier B: $105.50/unit, payment due in 30 days

• Number of days earlier Supplier A must be paid than Supplier B (longest days to pay – shortest days to pay)

• Number of days earlier Supplier A must be paid than Supplier B = Daily cost of capital assuming a 20% annual cost of capital.

o Cost of Capital/days in a year =

• Opportunity cost = # of days * daily cost of capital * purchase price of A

o Opportunity cost = o

• Effective price for Supplier A (in like terms as B) • Supplier A cost + opportunity cost =

Describe the result?

Answer 1

SOLUTION:

Number of days earlier Supplier A must be paid than Supplier B = 90 - 30 = 60 days

Cost of capital / days in a year = 20% / 365

Opportunity cost = 60 * 20%/365 * 100 = $ 3.29

Effective price for Supplier A = Supplier A cost + Opportunity cost

= 100 + 3.29

= $ 103.29

Supplies A and Supplier B are compared here in terms of costs that they would incur to supply an item while they offer different prices and different payment windows.

Supplier A incurs cost of $100 when the payment is due in 90 days. But in actual scenario, the cost incurred is $103.39 instead of $100 since the opportunity cost is not taken into account while calculating.

In this case, opportunity cost is calculated keeping the payment windows same for both the suppliers. Supplier B incurs a cost of $105.5 when his payment is due in 30 days. Supplier A's opportunity cost is calculated for the duration of different between payment windows of both the suppliers, i.e. 60 days.

If we analyze the result, if get to know that Supplier A is still cost effective as compared to Supplier B since the total cost incurred by Supplier A is less than Supplier B.