Question

Wisconsin Snowmobile Corp. is considering a switch to level production. Cost efficiencies would occur under level production, and after-tax costs would decline by \(36,000, but inventory would increase by \)300,000. Wisconsin Snowmobile would have to finance the extra inventory at a cost of 13.5 percent.

b. How low would interest rates need to fall before level production would be feasible?

Short answer

The interest rate should decline to 12%.

Step-by-step solution

Meaning of cost of inventory

The cost of inventory refers to the total cost incurred by the organization for ordering and storing the inventory. This cost is important to determine the amount of inventory that an organization should hold at a given time.

Calculation of average inventory

The interest rate should decline to 12% and then level production will be feasible for the company.

$\begin{array}{rcl}\mathrm{Decline}\mathrm{required}\mathrm{in}\mathrm{interest}\mathrm{rate}& =& \frac{\mathrm{Savings}}{\mathrm{Increased}\mathrm{inventory}}\times 100\\ & =& \frac{\$36,000}{\$300,000}\times 100\\ & =& 12\%\end{array}$