Question 1

Shields carries a part that is popular in the manufacture of automatic sprayers. Demand for this part is 4,000 units per year; order costs amount to $30 per order, and holding costs total $1.50 per unit.
The company, which currently places four orders per year with its suppliers, is considering the implementation of an economic order quantity (EOQ) model to better manage its inventories. Preliminary EOQ calculations revealed an optimal order quantity of 400 units and total annual inventory costs of $600.
Required:
A. In comparison with its current policy, how much will Shields save by adopting the EOQ model?
B. Briefly explain the philosophical difference between the EOQ model and the just-in-time model. Which of the two models will likely result in lower holding costs for the firm? Why?

Accepted Answer

A. Shields is currently ordering four times each year, resulting in order costs of $120 ($30 x 4). Each order is for 1,000 units (4,000 ÷ 4), which gives rise to an average inventory of 500 units (1,000 ÷ 2) and holding costs of $750 (500 x $1.50). Total costs under the current policy are $870 ($120 + $750), and the EOQ produces a $270 savings for the company ($870 - $600).
B. The EOQ model assumes that some inventory is necessary for business operations, and the goal is to optimize the order quantity to produce a situation where ordering costs equal holding costs. In contrast, under JIT, holding inventory in a warehouse is deemed to be inefficient and wasteful. Thus, inventory should be minimized and even eliminated, if possible.
Inventory under a JIT system is typically lower and, thus, holding costs are lower with this approach.

Question 2

Cartwright Graphics uses a special purpose paper on 80% of its jobs. The paper is purchased in 100-sheet packages at a cost of $100 per package. Management estimates that the cost of placing and receiving a typical order is $15, and the annual cost of carrying a package in inventory is $1.50. Cartwright uses 2,600 packages each year. Production is constant, and the lead time to receive an order is 1 week.
The economic order quantity is approximately:

Accepted Answer

Using the economic order quantity formula:
EOQ = sqrt((2SD)/(H))
where:
S = annual demand (packages)
D = cost of placing and receiving an order ($)
H = annual cost of carrying one unit of inventory ($)

We can calculate:
S = 2,600 packages/year
D = $15/order
H = $1.50/package

First, we need to calculate the total annual cost of ordering and carrying inventory at the EOQ level. This can be done using the following formula:
Total Annual Cost = ((DS)/Q) + ((QH)/2)
where:
Q = order quantity

We can plug in values and calculate the total annual cost for different order quantities. The EOQ is the order quantity that results in the lowest total annual cost.

Using a spreadsheet or a calculator, we can find that the EOQ is approximately 228 packages. Therefore, the best choice is C).

Question 3

Which of the following is classified as an inventory shortage cost?

Accepted Answer

Inventory shortage costs include all the consequences of not having enough inventory on hand, including both production disruptions and the loss of sales and customers. These shortages can lead to delays in production and dissatisfied customers who may turn to competitors, thus directly impacting a company's revenue and reputation.

Question 4

When comparing EOQ and JIT inventory systems, which of the following statements is false?

Accepted Answer

JIT argues that safety stocks should be eliminated or minimized, as they represent additional inventory that is not needed for immediate use and increases the risk of waste and obsolescence.

Question 5

Cartwright Graphics uses a special purpose paper on 80% of its jobs. The paper is purchased in 100-sheet packages at a cost of $100 per package. Management estimates that the cost of placing and receiving a typical order is $15, and the annual cost of carrying a package in inventory is $1.50. Cartwright uses 2,600 packages each year. Production is constant, and the lead time to receive an order is 1 week.
The reorder point is:

Accepted Answer

The reorder point is calculated as the lead time demand. With a constant production and a lead time of 1 week, the weekly demand is 2,600 packages per year divided by 52 weeks, which equals 50 packages.

Question 6

Economic Order Quantity, timing of orders and safety stock are three important considerations in inventory management.
Required:
A. Explain each of these considerations.
B. How is EOQ affected by the timing of orders and safety stock?

Accepted Answer

The answer of Economic Order Quantity, timing of orders and...

Question 7

Inventory holding costs would typically include all of the following except:

Accepted Answer

Transportation costs are not considered inventory holding costs. These costs are associated with transporting goods to the warehouse or from the warehouse to customers or retailers. Inventory holding costs include expenses associated with storing and maintaining inventory, such as insurance, theft, obsolescence, and warehouse rent.

Question 8

Which of the following does not minimize ordering costs when using JIT purchasing?

Accepted Answer

Maintaining a safety stock increases inventory levels and contradicts the purpose of JIT, which is to reduce inventory and associated costs.

Question 9

Burgoon uses an economic order quantity model and has determined an optimal order size of 500 units. Annual demand is 10,000 units, ordering costs are $50 per order, and holding costs are $4 per unit. The company's annual ordering and holding costs total:

Accepted Answer

The total annual ordering cost is (10,000 units / 500 units per order) * $50 = $1,000. The total annual holding cost is (500 units / 2) * $4 = $1,000. Therefore, the total annual ordering and holding costs are $1,000 + $1,000 = $2,000.

Question 10

When considering safety stock and its effect on EOQ, which of the following statements is false?

Accepted Answer

Safety stock increases inventory holding costs, as it adds to the total amount of inventory that needs to be carried. The other statements are true: A) Safety stock represents a buffer to account for unexpected increases in demand or lead time variability. B) Reorder point is calculated as the sum of safety stock and the expected demand during replenishment lead time. D) Safety stock helps avoid stockouts and the potential costs associated with them. E) Variability in demand or lead time makes safety stock more desirable to reduce the risk of stockouts.

Question 11

At the economic order quantity:

Accepted Answer

The Economic Order Quantity (EOQ) model is designed to minimize the total annual inventory costs, which includes both holding costs and ordering costs. At the EOQ point, holding costs equal ordering costs, which leads to the minimization of the total costs.

Question 12

When graphing the EOQ, which of the following statements is false?

Accepted Answer

The answer of When graphing the EOQ, which of the...

Question 13

Inventory holding costs typically include:

Accepted Answer

Inventory holding costs typically include both costs of deterioration, theft, or spoilage and forgone interest on money tied up in inventory. Other possible costs may include warehouse rent, insurance, obsolescence, and taxes. However, the options provided in the question only include the two most common types of holding costs.

Question 14

Shields carries a part that is popular in the manufacture of automatic sprayers. Demand for this part is 4,000 units per year; order costs amount to $30 per order, and holding costs total $1.50 per unit. The company is considering the implementation of an economic order quantity model in an effort to better manage its inventories.
Required:
A. Compute the economic order quantity.
B. Compute total annual inventory costs if Shields follows the EOQ policy.

Accepted Answer

The answer of Shields carries a part that is popular...

Quiz 20: Inventory Management