Appendix 4 • Suggested answers to selected problem questions13.5 North Anglia Engineering Ltd
(a) Optimum level of inventories holding
Businesses hold inventories to the extent that the financial benefits of holding them are out-
weighed by those of not holding them to the maximum extent.
The costs of holding inventories include:l The cost of financing the inventories. Finance is tied up in inventories.
l Storage costs. Storing inventories costs money. If the inventories are valuable or fragile,
these costs could be considerable.
l Insurance costs. Inventories would normally be insured against losses and damage.
l Obsolescence costs. Items of inventories may become obsolescent during the inventories
holding period. This may seriously reduce their value.
The costs of holding insufficient inventories include:
l Loss of customer goodwill. If a customer cannot be supplied from inventories that cus-
tomer may go elsewhere, never to return.
l Production dislocation. Running out of an inventories line may mean that production has
to cease, which can be very expensive in terms of lost production time and other pro-
duction costs.
l Loss of flexibility. Holding very low levels of inventories makes it difficult to respond
rapidly to an opportunity to increase output to meet an unexpected demand or to engage
in large production runs that could yield economies of scale.(b) Reasons for large inventories levels
The points that should be investigated in an attempt to identify the reason for large invent-
ories levels include the following:
l Optimum order quantities. Does the business use any technique for deducing the opti-
mum size of order or manufacturing batch?
l Inventories reorder levels. Are there established inventories reorder levels for each invent-
ories line such that a new order is triggered when the reorder level is reached?
l Budgets. Are inventories requirements carefully planned and budgeted?
l Reliable inventories records. Is there reliable information available on a day-to-day basis
that provides a basis for decisions relating to inventories management?
l Ratios. Are ratios such as inventories turnover systematically used to monitor invent-
ories levels, both generally and in respect of particular inventories lines?
l Security and authorisation. Are there clear rules established surrounding the authority to
order and issue inventories?14.1 ABB plc and CDD Ltd
Pre-merger value of ABB plc =£12m/20% =£60m
Post-merger value of ABB plc =£60m +£27.5m =£87.5m
Estimated cost of capital =£14m/£87.5m ×100% =16%14.3 Thruster plc and Relaxation plc
Pre-takeover price per share of Thruster plc £
EPS [48/(170 ×2)] 0.1412
Price per share (£0.1412 ×18) 2.5416Chapter 14
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