You are a financial analyst for the Ajax Company, which uses about $1 million of

Question

You are a financial analyst for the Ajax Company, which uses about $1 million of inventory per month. The purchasing manager has come to you for help with a buying decision. He can get a big discount on $15 million of inventory by buying it all at once. However, there is some risk of obsolescence when buying that far in advance. He understands that large purchases are frequently analyzed by means of capital budgeting techniques, and asks for your help in deciding whether or not to buy the specially priced inventory. How would you advise him? Is capital budgeting appropriate?

Explanation / Answer

Since we can not hold the inventory for the long time therefore we can not consider the inventory as capital budgeting issue.In this case, however, capital budgeting thinking may help by putting timevalue concepts into the purchasing manager's thinking.The purchase department should decide first that wht will be the NVP of the amount if he will purchase the inventory on $1 milion basis instead of $15 million.The inventory's "NPV" is then the difference between that value and thecost at which it is offered.Further there will be also a fear of obsolescence when buying huge stock at a time therefore i think $1 million should be purchase at a time

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