Perform a price analysis with a 10% annual cost of capital.
Two suppliers have quoted the following pricing and payment terms for the procurement of a certain part:
Supplier A $121.25/unit, payment due in 45 days
Supplier B $120.00/unit, payment due on delivery
What will be an ideal response?
To equitably compare these two prices, we need to adjust for the different payment windows. We do so by adding an opportunity cost to the supplier that requires earlier payment to account for the interest that we would have been able to make on that money had we been able to keep it in our accounts for the longer payment window. To make the adjustment, we need to determine the following:
1. Number of days earlier supplier B must be paid (longest days to pay - shortest days to pay)
45 days - 0 days = 45 days
2. Your organization's daily cost of capital
If we assume an annual cost of capital of 10 percent, the daily cost of capital would be 0.010/365 = 0.000274
3. Opportunity cost = number of days earlier * daily cost of capital * purchase price
45 * 0.000274 * $120.00 = $1.479
4. The effective price for supplier B: $120.00 + $1.479 = $121.479
As a result of the price analysis, we conclude that although supplier A offers the item at a higher price, the effective price for supplier B was actually higher than supplier A because of the different payment window. The key to price analysis is ensuring that the prices are compared on an equivalent basis.
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