Seasonal Inventory Financing at Northline Cycles
Northline Cycles is an independent three-store bike retailer preparing its spring order. It forecasts demand of 1,200 commuter bikes for the season, with a plausible range of 1,000 to 1,400. Each bike costs $400 and retails for $650. The supplier offers terms of 2/10, net 45. Northline can draw on a bank line at 9% annual interest, but its cash balance is tight because it just renovated a store. Unsold bikes can be marked down to $450 and are likely to sell, but storage costs $8 per bike for the season. The owner must decide whether to pay early and capture the discount, and how many bikes to order. The operations manager favors ordering 1,400 to avoid stockouts; the finance manager favors 1,000 to protect cash. Online competitors can fill a stockout within three days, but Northline loses the sale and some goodwill.
1. Should Northline borrow on its bank line to take the supplier's 2/10, net 45 discount? Show the calculation and state any conditions.
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Yes, if the bank line is available and the order size is roughly the planned 1,200 bikes. The discount is 2% of the invoice. At 1,200 bikes × $400 = $480,000, paying early saves $9,600. To pay on day 10 instead of day 45, Northline must finance the discounted invoice for 35 days: $480,000 × 0.98 = $470,400. Interest at 9% APR is $470,400 × 0.09 × 35/365 ≈ $4,059. Net benefit ≈ $9,600 − $4,059 = $5,541. The effective annualized return from taking the discount is much higher than 9%, so borrowing is rational. Conditions matter: the bank line must have enough undrawn capacity, the supplier must actually apply the discount, and Northline must not sacrifice a needed cash buffer for payroll or rent. If the order is cut to 1,000 bikes, the dollar savings fall, but the logic still holds because the discount rate and financing period do not change much. The decision should be paired with a smaller, data-driven order rather than an all-or-nothing choice.
2. Recommend an order quantity. Use underage and overage reasoning and reconcile the operations and finance views.
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Estimate the cost of ordering one bike too few versus one too many. If Northline stocks out, it loses the gross margin: $650 − $400 = $250, plus some goodwill, which is real but hard to quantify. If it orders one too many, it marks the bike down to $450, earning only $50 instead of $250, a $200 opportunity loss, plus $8 storage, for an overage cost of about $208. The critical ratio is underage ÷ (underage + overage) = 250 ÷ (250 + 208) ≈ 0.55. With mean demand 1,200 and a plausible range of 1,000 to 1,400, a normal approximation has a standard deviation of roughly 100 to 130; using 100, the optimal order is about 1,200 + (0.12 × 100) ≈ 1,212. Using a wider deviation, it is closer to 1,225. So the answer is roughly 1,200–1,225 bikes, not 1,400 and not 1,000. The operations manager is right that stockouts damage goodwill, but the $8 storage and $200 markdown loss make 1,400 expensive. The finance manager is right to protect cash, but 1,000 creates avoidable lost margin. A practical compromise is to order about 1,200, take the early-payment discount, and pre-negotiate a quick replenishment option with the supplier.
3. The supplier offers to extend terms to net 60 if Northline orders 1,400 bikes. Evaluate this trade-off.
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The extension improves cash timing but does not fix the inventory risk. If Northline orders 1,400 and demand is 1,200, it has 200 extra bikes. At a $200 opportunity loss plus $8 storage, that is about $41,600 in overage cost, before considering whether the markdown to $450 holds. Net 60 delays payment by 15 days beyond the current net 45, which on a $560,000 invoice is worth roughly $560,000 × 0.09 × 15/365 ≈ $2,071 in interest savings-far less than the expected markdown cost. The supplier may also be using extended terms to lock in a larger order that protects its own utilization, not Northline's margin. A better counter is to ask for net 60 on a 1,200-unit order, or to accept 1,300 units only if the supplier shares markdown risk through a return allowance or a guaranteed buyback. The decision should compare financing value with expected markdown and storage cost, not just the invoice timing.