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Q 2.

3 (Inventory Cost) A manufacturing company producing


medical devices reported $60,000,000 in sales over the last
year. At the end of the same year, the company had
$20,000,000 worth of inventory of ready-to-ship devices.
A. Assuming that units in inventory are valued (based on
COGS) at $1,000 per unit and are sold for $2,000 per unit,
how fast does the company turn its inventory? The
company uses a 25 percent per year cost of inventory. That
is, for the hypothetical case that one unit of $1,000 would sit
exactly one year in inventory, the company charges its
operations division a $250 inventory cost.

B. Whatin absolute termsis the per unit inventory cost for


a product that costs $1,000?

Sales
Inventory

$60,000,000
$20,000,000

Part A
Selling Price
COGS per Unit

$2,000
$1,000

Units Sold
Total COGS

30,000
$30,000,000

Flow Time (in


years)=Inventory/Flow rate
Inventory Turns

(Flow)

(Flow
Rate)
(Flow
Rate)

0.666667
1.5

Part B
Per-Unit Inventory Cost
Percentage
Per-Unit Inventory Cost (in $)

16.66667
166.6667

Applying Littles Law to Financials allows us to see how efficient organization


is.
1

In this particular problem we're concerned with the process so that the
average inflow ( going into the process ) and the average outflow (coming
out of the process). How long does it take for a dollar to get through the
entire process how many dollars are sitting in inventory and how many
dollars go through the entire process in a period of time

Q 2.6 (Highway) While driving home for the holidays, you can't
seem to get Little's Law out of your mind. You note that your
average speed of travel is about 60 miles per hour. Moreover, the
traffic report from the WXPN traffic chopper states that there is an
average of 24 cars going in your direction on a one-quarter mile
part of the highway. What is the flow rate of the highway (going
in your direction) in cars per hour?

Speed (in MPH)


Inventory
Flow time for 1/4-mile stretch of highway
(in hrs)
Throughput (in cars per hour on
highway)
Throughput (in cars per minute on

60
24
0.00416
7
5760
96

highway)

This problem represents is an application of Littles Law to transportation


science.

We look at 1 mile of highway as our process. Since the speed is 60


miles per hour, it takes a car 1 minute to travel through the process
(flow time).

There are 24 cars on of a mile, i.e. there are 96 cars on the 1 mile
stretch(inventory).

Inventory= Flow Rate * Flow Time: 96 cars=Flow Rate * 1 minute Thus, the
Flow Rate is 96 cars per minute, corresponding to 96*60=5760 cars
per hour.

Q2.9 (Major U.S. Retailers) The following table shows financial


data (year 2004) for Costco Wholesale and Wal-Mart, two major
U.S. retailers.

Assume that both companies have an average annual holding


cost rate of 30 percent (i.e., it costs both retailers $3 to
hold an item that they procured for $10 for one entire
year).
A. How many days, on average, does a product stay in
Costco's inventory before it is sold? Assume that stores
are operated 365 days a year.
B. How much lower is, on average, the inventory cost
for Costco compared to Wal-Mart of a household
cleaner valued at $5 COGS? Assume that the unit cost
of the household cleaner is the same for both
companies and that the price and the inventory
turns of an item are independent.
Costco
Inventories ($MM)

3643
3

Wal-Mart
29447

Sales (net $MM)


COGS ($MM) (Flow Rate)
Part A
Flow Time (in days)
Part B
Per-Unit Inventory Cost
Percentage
Per-Unit Inventory Cost (in $)

48106
41651

286103
215493

31.92468

49.87705

2.623947

4.099484

0.131197

0.204974

Difference between inventory cost for $5 COGS item for


the two companies:

0.073777

This problem is another example of Applying Littles Law to Financial factors.


In this case Littles law enables us to compare the efficiency of two
organizations. Also, this problem illustrates how one product behaves
differently (in terms of costs) in each company.

Q2.10 (McDonald's) The following figures are taken from the 2003
1
financial statements of McDonald's and Wendy's. Figures are in
million dollars.

a.

In 2003, what were McDonald's inventory turns? What

were Wendy's inventory turns?

b.

Suppose it costs both McDonald's and Wendy's $3

(COGS) per their value meal offerings, each sold at the


same price of $4. Assume that the cost of inventory for
both companies is 30 percent a year. Approximately how
much does McDonald's save in inventory cost per value
meal compared to that of Wendy's? You may assume the
inventory turns are independent of the price.

Inventory
Revenue

McDonald's
129.4
17140.5

Wendy's
54.4
3148.9

Cost of Goods Sold


Gross Profit
Part A
Flow Time (in years)
Inventory Turnover

11943.7
5196.8

1634.6
1514.4

0.01083416
92.3006182

0.03328
30.04779

Part B
Per-Unit Inventory Cost
0.32502491
Percentage
Per-Unit Inventory Cost (in
0.00975075
$)
Difference between Wendy's and McDonald's inventory cost per
value meal (in $):

0.998409
0.029952
0.0202
02

Inventory turns for McDonalds were 92.3. They were 30.05 for
Wendys.

McDonalds has per unit inventory costs of 0.32%, which for a 3$


meal about$0.00975. That compares to 0.998% at Wendys where
the cost per meal is $0.0299

This problem allows us to compare the two restaurants in terms of


efficiency affecting the length of time (flow) and inventory cost percentage.
Again, this is an example of the application of Littles Law to aid the process
of company assessment with the intention of improvement.

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