Inventory decision, opportunity costs. Lawn World, a manufacturer of lawn mowers, predicts that it will purchase 264,000 spark plugs next year. Lawn World estimates that 22,000 spark plugs will be required each month. A supplier quotes a price of $7 per spark plug. The supplier also offers a special discount option:
If all 264,000 spark plugs are purchased at the start of the year, a discount of 2% off the $7 price will be given. Lawn World can invest its cash at 10% per year. It costs Lawn World $260 to place each purchase order.
1. What is the opportunity cost of interest forgone from purchasing all 264,000 units at the start of the year instead of in 12 monthly purchases of 22,000 units per order?
2. Would this opportunity cost be recorded in the accounting system? Why?
3. Should Lawn World purchase 264,000 units at the start of the year or 22,000 units each month? Showyour calculations.