New England Charm, Inc.specializes in selling scented candles.The company has established a policy of reordering inventory every 30 days.A recently employed MBA has considered New England'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
Safety stock...............= 0
A) Total costs will be the same, since the current policy is optimal.
B) Total costs under the current policy will be less than total costs under the EOQ by $10.
C) Total costs under the current policy exceed those under the EOQ by $3.
D) Total costs under the current policy exceed those under the EOQ by $10.
E) Cannot be determined due to insufficient information.

Question

New England Charm, Inc.specializes in selling scented candles.The company has established a policy of reordering inventory every 30 days.A recently employed MBA has considered New England'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
Safety stock...............= 0
A) Total costs will be the same, since the current policy is optimal.
B) Total costs under the current policy will be less than total costs under the EOQ by $10.
C) Total costs under the current policy exceed those under the EOQ by $3.
D) Total costs under the current policy exceed those under the EOQ by $10.
E) Cannot be determined due to insufficient information.

Quizplus · Accepted Answer

The EOQ (Economic Order Quantity) model aims to minimize the total cost of inventory by finding the ideal order quantity. The formula for EOQ 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 $D/EOQ = 1000/100 = 10$ orders per year, or one order every 36.5 days (365 days / 10 orders). The current policy of ordering every 30 days results in more frequent orders (about 12 orders per year), increasing total costs due to higher ordering costs. To compare costs, calculate the total cost under both policies. Under the EOQ, the total cost includes the ordering cost ($10 orders * $10/order = $100$) and the carrying cost ($100/2 * $2 = $100$), totaling $200. Under the current policy, with approximately 12 orders per year, the ordering cost is $12 * $10 = $120$, and the carrying cost is slightly less due to smaller average inventory but not significantly different. The difference in costs primarily comes from the increased ordering costs, making the total costs under the current policy slightly higher than those under the EOQ, by a small margin, which aligns with option C's implication of a minor increase in total costs.