Question

Please answer all parts for Upvote

The local Ford dealer is concerned about having the right amount of parts in their service department. One SKU is very expensive, costing the dealer $475.   In a typical week, they use 24 of these parts. Their supplier usually gets new orders to the dealer within 3 weeks. Currently they order 6 weeks work of these parts at a time (ie, 144). They use a 12% annual carrying charge rate on all of their inventory.

a. For their current replenishment policy, what is the annual cost of carrying inventory?

b. For their current replenishment policy, what is the total annual incremental inventory cost for this item?

c. Draw a rough graph of how the two competing costs of this inventory policy behave as they try different reorder quantities. Label all components of the graph.

d. What is the EOQ for this item (calculate the number)?

e. If their current policy is not optimal, what type of cost or expense do their need to attempt to improve in order to get to the optimal, and why?

f. Suppose that they want to cut their order quantity down to, say, only 12 units at a time. What would the cost to reorder have to be in order that this new policy be optimal?

Answer 1

Cost per unit: $475

Demand per week = 24 units

Annual Demand = 24units*52 weeks = 1,248 units

Units per order = 144

a.      Annual Carrying Cost

Carrying cost p.a. = 12%

Carrying cost per unit = 12% of $475 = $57

Annual Carrying cost = $57*1248units = $71,136

b.     Annual Incremental Cost

Incremental costs arise when there is an increase in the quantity of production or in case of quantity discounts given by the suppliers of materials. In the current case the dealer typically uses 24 parts per week and there is no mention of any change in quantities required. The supplier also does not offer any quantity discount. Hence there is no incremental cost incurred on the purchase of this item.

d.     Economic Order Quantity

EOQ=√(2AQ)/C

Where A= Annual Demand

             Q= Annual Quantity

             C= Carrying Cost

EOQ =√(2*1,248*475)/57

          = √(11856000/57

          = 144.22