Malia Inc. has $110 million in sales. The company expects that its sales will in

Question

Malia Inc. has $110 million in sales. The company expects that its sales will increase by 5% this year. Malia Inc.’s CFO uses a simple linear regression to forecast the company’s inventory level for a given level of projected sales. On the basis of recent history, the estimated relationship between inventories and sales (in millions) is as follows: Inventories = $9 + 0.0875 (Sales) Given the estimated sales forecast and the estimated relationship between inventories and sales, what are your forecasts of the company’s year-end inventory level and its inventory turnover ratio?

Explanation / Answer

Sales = $110 million

Inventory in current year is calculated below using given equation:

Inventories = $9 + 0.0875 × Sales

                   = $9 + 0.0875 × $110 million

                   = $9 + $9,625,000

                   = $9,625,009

Growth rate in sales = 5%

Sale next year = $110 × (1 + 5%)

                       = $115.5 million

Sales value next year will be $115.50.

Equation for calculate inventory is given below:

Inventories = $9 + 0.0875 × Sales

                   = $9 + 0.0875 × $115.50 million

                   = $9 + $10,106,250

                   = $10,106,259

Value of inventory next year will be $10,106,259.

Average inventory = ($9,625,009 + $10,106,259) / 2

                               = $9,865,634

Average inventory is $9,865,634.

Inventory Turnover

Inventory turnover ratio is calculated below using following formula:

Inventory turnover = Net Sales / Average inventory

                                  = $115,500,000 / $9,865,634

                                  = 11.70

Hence, Inventory turnover ratio is 11.70.

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