Figure 24-2
Hapsburg Manufacturing purchases components produced by Little Company in the manufacture of its main product. For the next year, Hapsburg expects to use a total of 20,000 parts. Hapsburg typically orders 2,000 units at a time. The cost of placing an order is £100, and the average annual cost of carrying one unit of inventory is £5.
-Refer to Figure 24-2. Hapsburg's total inventory cost is
A)£5,100.
B)£6,000.
C)£10,000.
D)£20,000.

Question

Quizplus · Accepted Answer

To calculate the total inventory cost, we need to first find the order quantity that minimizes the total cost. Using the Economic Order Quantity (EOQ) formula, we get:

EOQ = sqrt((2DS)/H)
where:
D = demand (20,000 units)
S = ordering cost per order (£100)
H = holding cost per unit (£5)

EOQ = sqrt((2 x 20,000 x 100)/5) = 2,828.43

Since Hapsburg typically orders 2,000 units at a time, they should place 14 orders per year (20,000/2,828.43). Therefore, the total ordering cost will be 14 x £100 = £1,400.

The total carrying cost is calculated by multiplying the average inventory level by the holding cost per unit. The average inventory level can be calculated as half of the EOQ (since we assume a constant demand rate), so it is:

Average inventory level = EOQ/2 = 2,828.43/2 = 1,414.21

Therefore, the total carrying cost is:

Carrying cost = Average inventory level x Holding cost per unit
= 1,414.21 x £5 = £7,071.05

Adding the ordering cost and the carrying cost, we get the total inventory cost:

Total inventory cost = Ordering cost + Carrying cost
= £1,400 + £7,071.05 = £8,471.05

Therefore, the best choice is B, with a total inventory cost of £8,471.05.

Figure 24-2 Hapsburg Manufacturing Purchases Components Produced by Little Company in the in the Manufacture