A firm uses $20,000 of an item per year. The carrying cost is 25%, the cost of ordering is $10 and the order quantity is $1,000. The annual total cost of carrying plus ordering would be:
A) $2,500
B) $5,000
C) $500
D) $816
E) none of the above

Question

Quizplus · Accepted Answer

The annual carrying cost can be calculated as 25% of the cost of one unit multiplied by the average inventory level. The average inventory level is half of the order quantity, since orders are placed when inventory reaches 0.5 units. Thus, the carrying cost is:

0.25 x cost of one unit x 0.5 order quantity = 0.125 x $1,000 = $125

The annual ordering cost is the cost per order multiplied by the number of orders placed. Since the firm orders $20,000 / $1,000 = 20 times per year, the ordering cost is:

$10 x 20 orders = $200

The total annual cost of carrying plus ordering is the sum of the annual carrying cost and the annual ordering cost:

$125 + $200 = $325

Therefore, the best choice is D, $816 is far too high, A and C are too low, and B is not a valid option.

A Firm Uses $20,000 of an Item Per Year