Question

Effect of EOG ordering on supplier costs (continuation of Problem 20-29). IMBest Computers supplies computers to Computers 4 U. Terry Moore, the president of IMBest, is pleased to hear that Computers 4 U will be ordering 500,000 computers. Moore has asked his accounting and production departments to team up and determine the best production schedule to meet Computers 4 U’s desired delivery schedule. Assume that the computers would be ordered in batches of 2,000 and that there would be 250 orders annually. Because Computers 4 U’s employees work a 5-day work week for 50 weeks a year, they would expect to receive an order every day. They have developed the following two production alternatives:

A. IMBest could produce the 10,000 units demanded per week (2,000 >< 5) in one large run on Mondays. Shipments would be made each day. If this option is chosen then IMBest would only have to set up the machines once a week, but would incur carrying cost to hold the computers in inventory until Computers 4 U’s desired delivery date.

B. IMBest could rearrange its production schedule during the week and produce 2,000 computers each day of the week, totaling 10,000 computers per week. Shipments would be made at the end of each production day. If it chooses this alternative, then it will incur setup costs every day, but carrying costs would be negligible and are assumed to be zero.

1. If setup costs are $1,000 per setup and carrying costs are $50 per computer per year, what would be the annual cost of each alternative?

2.How much would carrying costs have to increase before the preferred alternative would change?

 

Answer 1

Effect of EOQ ordering on supplier costs (continuation of Problem 20-29). 

 

1.

i) Set up cost = Cost per setup × annual setups

 

Alternative A: $1,000 × 50 setups = $50,000

Alternative B: $1,000 × 250 setups = $250,000

 

ii) Carrying Cost = Average inventory level × carrying cost

 

Alternative A: 10,000  ÷  2 × $50 = $250,000

Alternative B: Assumed to be $0 (because computers are shipped on the day they are  produced)

 

iii) Total relevant cost

 

Alternative A: $50,000 + $250,000 = $300,000

Alternative B: $250,000 + $0 = $250,000

 

            Costs would be lower if IMBest produced computers every day.

2. 

Let C = carrying costs per unit

 

            Alternative A: Total cost = $50,000 + (10,000 ÷ 2) × C

            Alternative B: Total cost = $250,000 + $0

 

    Equating these costs, $50,000 + $5,000C = $250,000

                                              $5,000C = $200,000

                                                             C = $40

            

If carrying costs fall below $40 per unit, IMBest would be better off producing the

computers once a week.

  Equating these costs, $50,000 + $5,000C = $250,000

                                              $5,000C = $200,000

                                                             C = $40