GEP Manufacturing is mulling over a plan to rent a proprietary inventory control system at an annual cost of $4.5 million. The firm predicts its sales will remain relatively stable at $585 million and its gross profit margin will continue to be 28 percent.
It expects that as a result of the new inventory control system its average age of inventory (AAI) will drop from its current level of 83 days to about 46 days. The firm's required return on similar-risk investments is 12 percent. Assume a 365-day year.
a. Calculate GEP's average inventory investment both currently and assuming it rents the inventory control system.
b. Use your findings in part (a) to determine the annual savings expected to result from the proposed inventory control system.
c. Based on your finding in part (b), would you recommend that GEP rent the inventory control system? Explain your recommendation.