Question

1. The following data refer to various annual costs relating to the inventory of a single-product
company that requires 10,000 units per year:

Order cost	$ .05
Transportation-in on purchases	.18
Storage	.16
Insurance	.10

Total per year
Interest that could have been earned on alternate investment of funds $800
Required:
a. What is the annual carrying cost per unit? b. Explain the use of carrying cost.

2. Umberg Merchandise Company’s cost of goods sold last month was $1,350,000. the
Merchandise Inventory at the beginning of the month was $250,000 and there was $325,000
of Merchandise Inventory at the end of the month. What are the Umberg’s merchandise
purchases?

3. Xander Company anticipates that usage of Component T will be 100 units daily, which
equates to around 25,000 for the year. The material is expected to cost $5 per unit. Once an
order is placed with its vendor, it takes five days to receive the goods, and the cost of placing
each order is $50. As a result, Xander keeps 1,000 units on hand to avoid stockouts. The
carrying cost associated with each unit is $10.

Required:
a. Compute the order point.
b.Determine the most economical order quantity
c.Why we calculate the order point? Explain.

4. The following data pertains to Western Company’s materials inventory:

Number of pounds required annually 16,000
Cost of placing an order $20
Annual carrying cost per pound of material $4

Required:

a. What is Western Company’s EOQ?

b. What is the application of EOQ?

c. Expected annual usage of a particular raw material is 1,200,000 units, and standard
order size is 10,000 units. The invoice cost of each unit is $145, and the cost to place
one purchase order is $105. What is the estimated annual order cost?

5. The Bisset Corporation uses Raw Material A in a manufacturing process. Information as to
balances on hand, purchases, and requisitions of Raw Material A is given in the following
table.

Answer 1

1. (a) Calculation of the annual carrying cost per unit is as follows:-

Particulars	Amt. in $
Storage Cost per unit	0.16
Insurance Cost per unit	0.10
Interest that could have been earned on alternate investment = $800 No. of units of the product = 10,000
Interest expense per unit ($800/10,000)	0.08
Carrying costs per unit	0.34

Therefore, the annual carrying cost per unit = $0.34.

Carrying cost is also known as stock holding cost. It represents the cost of storing an item in the inventory. It is proportional to the amount of inventory and the time over which it is held. It is usually represented as rate per unit or as a percentage of the inventory value. The main components of carrying cost are:- storage cost like tax, depreciation, maintenance of the building, utilities etc., insurance of the inventory, deterioration in inventory because of pilferage, fire etc., the opportunity cost of funds (i.e. the interest foregone in alternative investment of the fund).

The carrying cost and the inventory size is positively correlated and move in the same direction. If the inventory level rise so does the carrying cost and vice versa. The sum of the ordering cost and the carrying cost represents the total cost of the inventory. This total cost is compared with the benefits arising out of inventory to determine the optimum level of inventory.

(2) The inventory or the merchandise stock of a company avalaible for sale includes the merchandise inventory in the beginning of the month plus the merchandise purchases made during that month. Hence, at the end of the month this entire merchandise stock either remains in the inventory or is sold out. The merchandise stock sold out results in the cost of goods sold. So, in other words, we can say that, the total of cost of goods sold and the merchandise stock at the end of the month represents the total merchandise stock available for sale in that month. Hence, the amount of merchandise purchases can be calculated as follows :-

Particulars	Amount in dollars
Cost of goods sold	$1,350,000
Add: Merchandise Inventory at the end of the month	$325,000
Merchandise of the month available for sale	$1,675,000
Less: Merchandise in the beginning of the month	$250,000
Merchandise purchases during the month	$1,425,000

Therefore, the Umberg’s merchandise purchases amount = $1,425,000.

(3) (a) Computation of the required order point:-

The order pont is also called the reorder point in inventory management. The reorder point is calculated as follows:-

Reorder point = (Average daily usage * Average lead time in days) + Safety stock

Here, it is given, Average daily usage = 100 units

Average lead time = 5 days

Safety stock = 1000 units

Therefore, the Reorder Point = (Average daily usage * Average lead time in days) + Safety stock

= {( 100 * 5) + 1000} units

= (500 + 1000) units = 1,500 units

hence the reqd. order point = 1,500 units

The economic order quantity or EOQ can be calculated by the following formula:-

where, Q^* = Economic order quantity

D = Annual demand in units

C_o = Ordering cost

C_h = Carrying cost

The data we get from the above given problem,

D = 25,000 units

C_o = $50

C_h = $10

Therefore, the required EOQ can be calculated as:-

=

=

= 500

Therefore, the required Economic order quantity = 500 units

The basic inventory mangement questions for any business unit is when to order & how much units to order. These two questions make the Order point or the reorder point a very important concept for the whole inventory management principle of a company. As the company grows in size, its entire process of manufacturing, holding adequate invesntories of raw materials & finished goods & reordering raw materials become more numerous & complex to deal with. It becomes difficult to calculate & predict the exact amount of raw materials requirements with accuracy. Hence, we need to construct a Reorder point formula which would help us to predict the amount of raw material requirements as well as the amount of inventory necessary to hold by the company with greater efficiency. In other words, the order point is the minimum level of inventory beyond which the company doesn't want to fall short in order to run its entire manufacturing process smoothly. The order point gives the firm an idea that when the company needs to replenish its supplies and also when the company needs to manufacture more finished goods in order to avoid a stockout situation. Hence, by calculating the oredr point the co. can regulate its stock or inventory much better and can avoid any supply chain bottlenecks.

The company always maintain a safety stock beyond which the firm doesn't allow its inventory of raw materials or finished goods to fall short. The company also needs to take into account the lead time or the delay in the delivery time. These two factors alongwith the company's average daily usage demands helps to calculate the reorder point of a firm. Thus the Reorder / Order Point is calculated as follows :

Reorder point = (Average daily usage * Average lead time in days) + Safety stock

4) a)

The economic order quantity or EOQ can be calculated by the following formula:-

where, Q^* = Economic order quantity

D = Annual demand in units

C_o = Ordering cost

C_h = Carrying cost

The data we get from the above given problem,

D = 16,000 units

C_o = $20

C_h = $4

Therefore, the required EOQ can be calculated as:-

Q^* = 400

Hence, the required EOQ = 400 units

c) Annual ordering cost = No. of orders * Ordering cost per order

No. of orders = Annual demand for raw materials / Standard order size

Here, it is given that,

Annual usage or demand of raw materials = 1,200,000 units

Standard order size = 10,000 units

Hence, No. of orders need to placed = 1,200,000 units / 10,000 units = 120

The cost to place one order is = $105

Therefore, the required annual ordering cost = No. of orders * Ordering cost per order = 120 * $105 = $12,600

The estimated annual order cost = $12,600

b) Application of EOQ :-

EOQ is the size of the order representing standard quality of material & it is that optimal order quantity for which the aggregate of the costs of procuring the inventory & costs of holding the inventory would be minimum.