Fullerton Wine Company is a retailer which sells vintage wines.The company has established a policy of reordering inventory every 30 days.A recently employed MBA has considered Fullerton's inventory problem from the EOQ model viewpoint.If the following constitute the relevant data,how does the current policy compare with the optimal policy?
Ordering cost= $10 per order
Carrying cost= 20% of purchase price
Purchase price= $10 per unit
Total sales for year= 1,000 units

Question

Quizplus · Accepted Answer

The Economic Order Quantity (EOQ) model is designed to minimize the total cost of inventory management by finding the ideal order quantity. The EOQ formula is $\sqrt{\frac{2DS}{H}}$, where $D$ is the demand (1,000 units/year), $S$ is the ordering cost ($10/order), and $H$ is the carrying cost per unit per year. The carrying cost per unit per year is 20% of the purchase price, which is $2 ($10 * 20%). Plugging these values into the EOQ formula gives $\sqrt{\frac{2*1000*10}{2}} = \sqrt{10000} = 100$ units. This means the optimal number of orders per year is $D/Q = 1000/100 = 10$ orders per year, or one order every 36.5 days (365 days / 10 orders). Fullerton's current policy of ordering every 30 days results in more frequent orders than the EOQ suggests (12 orders per year), leading to higher total costs due to increased ordering costs. To compare costs, we calculate the total cost under both policies. Under the EOQ, the total cost includes the ordering cost ($S*D/Q$) and the carrying cost ($H*Q/2$). Under the current policy, the ordering cost is higher because of more frequent orders. Without exact calculations of total costs here, the principle is that deviating from the EOQ results in higher total costs, making option C the correct choice by indicating that the current policy is more expensive than the EOQ model.

Fullerton Wine Company Is a Retailer Which Sells Vintage Wines