Question

Alexis Company uses 800 units of a product per year on a continuous basis. The product has a fixed cost of $50 per order, and its carrying cost is $2 per unit per year. It takes 5 days to receive a shipment after an order is placed, and the firm wishes to hold 10 days’ usage in inventory as a safety stock. Calculate the EOQ. Determine the average level of inventory. (Note: Use a 365-day year to calculate daily usage.) Determine the reorder point. Indicate which of the following variables change if the firm does not hold the safety stock: (1) order cost, (2) carrying cost, (3) total inventory cost, (4) reorder point, (5) economic order quantity. Explain.

Answer 1

Annual demand = 800 units.

Fixed cost = $50 per order

Carrying cost = $2 per unit

Shipping time = 5 days.

Economic order quantity = Under root of ( 2 * Fixed cost * Annual demand ) / Carrying cost per unit

= Under root of ( 2 * $50 * 800 / $2)

= under root of ( 40000 )

= 200 units.

Average level of inventory = EOQ/2 + buffered inventory

Buffered inventory = ( Per day inventory * Days for safety stock )

= ( 800 units / 365 days * 10 days )

= 22 units.

Average level of inventory = (200 / 2) + 22

= 122 units

Reorder quantity = Normal consumption during lead time + Safety stock

= ( 800 / 365 * 5 days ) + 22 units

= 11 units + 22 units

= 33 units.

Change in variables =

1. The Order cost remains same since we still need to order same quantity.

2. Carrying cost will decrease as there is less stock to maintain.

3. Total inventory cost will decrease because of lowering carrying cost.

4. Reorder point becomes lower since there is no safety stock requirement.

5. Economic order quantity will also decrease since carrying cost per unit decreases.