Question

Wheels & Deals Limited uses 60,000 batteries each year in its production of motorcycles at a cost of $450 per battery. The cost of placing an order is $75.00. The cost of holding one unit of inventory for one year is 0.5% of the unit purchase price. Currently, Wheels & Deals Limited places 12 orders of 5,000 batteries per year. Compute the cost Wheels & Deals’ current inventory policy. Is this the minimum cost? Explain

Answer 1

Total cost under Wheels & Deals can be computed as

Total cost for the year. = annual ordering cost. + annual carrying cost

i). Annual ordering cost. = (Annual consumption * cost per order) /quantity ordered

= ( 60,000*$75)/5000. = $900

ii).annual carrying cost. = quantity ordered/2 * price per unit*carryingcost%.

= 5000/2 * 450 * 0.5% = $5625

a). Total cost of current inventory policy for the company is

=$ 5625+$900 = $6595

Now, minimum inventory cost that a company would probably incur depends on ideal order quantity a company should purchase called economic order quantity (EOQ).

Here, EOQ. = square root of [(2*annual consumption* cost per order) /carrying cost per unit per annum]

. = 2000 units

Number. Of orders that a company can place with EOQ is

= 60,000/2000 = 30 orders

Now, ordering cost. = 30*75 = $2250

Carrying cost. = (2000/2)*2.25 = $2250

b). Total cost when EOQ is ordered. = $2250 + $2250 = $4500

therefore, from a) And b) above, it is clear that minimum cost is incurred at economic order quantity