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Inventory Management Practice Problems On EOQ Problem-Tutorial For Bfe

The document provides tutorial material on inventory management and the economic order quantity (EOQ) model. It includes an example problem calculating EOQ for a company that produces bicycles. It also defines relevant terms like ordering cost and holding cost. The EOQ formula is presented and explained. Examples are given to illustrate how to determine which costs are relevant for EOQ calculation. Factors like fixed versus variable costs and how costs change with inventory levels or order quantities are discussed.

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69 views

Inventory Management Practice Problems On EOQ Problem-Tutorial For Bfe

The document provides tutorial material on inventory management and the economic order quantity (EOQ) model. It includes an example problem calculating EOQ for a company that produces bicycles. It also defines relevant terms like ordering cost and holding cost. The EOQ formula is presented and explained. Examples are given to illustrate how to determine which costs are relevant for EOQ calculation. Factors like fixed versus variable costs and how costs change with inventory levels or order quantities are discussed.

Uploaded by

Boy hw
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as DOCX, PDF, TXT or read online on Scribd
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TUTORIAL QUESTIONS & MATERIAL FOR CONSIDERATION

Inventory Management Practice problems on EOQ Problem


1 A company makes bicycles. It produces 450 bicycles a month. It buys the tires for bicycles
from a supplier at a cost of $20 per tire. The company’s inventory carrying cost is estimated
to be 15% of cost and the ordering is $50 per order.
a. Calculate the EOQ In this problem
b. What is the number of orders per year?
c. Compute the average annual ordering cost.
d. Compute the average inventory.
e. What is the average annual carrying cost?
f. Compute the total cost.

Economic Order Quantity (EOQ)

Definitions
Economic Order Quantity (EOQ) is the order quantity that minimizes total inventory costs.

Order Quantity is the number of units added to inventory each time an order is placed.

Total Inventory Costs is the sum of inventory acquisition cost, ordering cost, and holding
cost.

Ordering Cost is the cost incurred in ordering inventory from suppliers excluding the cost of
purchase such as delivery costs and order processing costs.

Holding Cost, also known as carrying cost, is the total cost of holding inventory such as
warehousing cost and obsolescence cost.

Explanation
Total inventory cost is comprised of the following main costs:

 Cost of purchase
 Order Costs
 Holding Costs

If we change the order quantity, it can affect the different types of inventory costs in different
ways.

Larger order size results in lower order costs because fewer orders need to be placed to cover
the annual demand. This however results in higher holding costs because of the increase in
inventory levels.

Conversely, smaller order size results in lower holding costs because of the decline in
average inventory level. However, as lower quantity of inventory is ordered each time, the
number of orders needed to increase in order to fulfill the annual demand which leads to
higher ordering costs. Reducing the order size may also affect the cost of purchase due to the
loss of trade discounts that are based on the order quantity.
So the question arises how we can find the optimal order quantity that minimizes the total
inventory costs.

EOQ model offers a method of finding the optimal order quantity that minimizes inventory
costs by finding a balance between the opposing inventory costs.

Formula
2 x Co x D
Economic Order Quantity = √ Ch

Where:

 Co is the cost of placing one order


 D is the annual demand
 Ch is the annual cost of holding one unit of inventory

How is the EOQ formula derived? [ + ]

Relevant Costs
When calculating EOQ, it is important to include only those ordering and holding costs that
are relevant. Any costs that are not incremental should be ignored while calculating EOQ.
Following examples illustrate the application of relevant costing in the calculation of EOQ.

Order Costs Relevance to EOQ calculation


Salary paid to clerk who processes orders. If increase in number of orders would not
result in overtime or hiring an additional
clerk, the cost will not be relevant to EOQ.
Supplier charges $5 delivery cost for each The total delivery expense will be the same
unit of inventory supplied. irrespective of the number of order deliveries
so it should be ignored in EOQ calculation.
Supplier charges $500 fixed delivery charge Delivery expense will increase with an
for each delivery. increase in number of orders so it should be
included in EOQ calculation.
Auto dealer transports cars from the car The annual insurance cost is fixed
factory to its showroom using its own trucks. irrespective of how many cars are transported
Insurance premium is paid to cover for any in one go and should therefore be ignored.
accidents during the transportation. $100
premium is paid for each vehicle that is
transported.

Holding Costs Relevance to EOQ calculation


Company earns a return of 15% on its The opportunity cost of holding one more
projects. One unit of inventory costs $100. unit of inventory for one year is
$15(15%x$100) which should be included in
EOQ calculation because more the number of
units of inventory that are held, higher the
opportunity cost of capital tied in inventory
purchase.
Company pays lease rentals of $20,000 for Warehouse rent is fixed and hence irrelevant
its warehouse. to EOQ calculation as the cost does not vary
to changes in the number of units of
inventory held.
Insurance premium of $10 per day is paid for The insurance cost rises with an increase in
each unit of inventory stored in the number of units held and is therefore relevant
warehouse to cover the risk of fire and theft. to EOQ.
0.2% of the average number of inventory The cost of damage and shrinkage (theft) of
units stored in the warehouse get damaged or inventory increases as more units of
stolen. inventory are held at the warehouse. The cost
should therefore be factored into EOQ
calculation.

Example

Jason owns a fish shop where he sells an exotic variety of tuna fish which he imports
from Japan.

Jason refrigerates the fish in a cold storage facility near his shop that charges him a
fixed annual fee of $1000 and variable charge of $5 per day for each fish container that
is stored.

Every morning, Jason brings fish from the cold storage to his shop for sale. Jason
estimates that he incurs $10,000 electricity cost each year on refrigerating the fish inside
his own shop.

Jason incurs the following ordering costs:

 Delivery charges of $10,000 per delivery


 Import duties of $300 per carton
 Custom fees of $200 per order
 Import license fee of $150 per annum

Jason currently imports fish by placing one order of 20 cartons every month. Each
carton costs $2,000.

Jason is wondering if he can save inventory costs by adopting EOQ model.

 a)    Calculate the current annual total inventory costs


 b)    Calculate the economic order quantity
 c)    Calculate the annual total inventory costs if EOQ is used

Modern supply chain management practitioners has advocated that value chain firms
should be customer focused in order to enhance efficiency of their firms in a
competitive business world. From this supply chain philosophy, explain in detailed
the concept of Customer Focused Supply Chain Management (CFSCM) and explain
the benefits associated with the concept

From supply chain performance metrics perspective, what is design collaboration and
how can design collaboration with suppliers help a PC or any high tech manufacturer
improve performance?

Explain why, for the same inventory level, a revenue-sharing contract results in lower
sales effort from the retailer than if the retailer has paid for the product and is
responsible for all remaining inventory.

What is supply chain flexibility/vulnerability? What are the three major risks
associated with a manufacturing firm what are risk management frameworks can you
as a manager in such an organisation put in place?

Supply chain management’s impact on the bottom line includes the ability to increase
sales by certain parameters, identify the parameters and explain

Describe the following concepts to the best of your knowledge:

- Investment characteristics fundamentalist


- Optimal service delivery in supply chain
- Supply chain optimisation
- Evaluate supply chain management in relationship with advantages and
disadvantages to the value chain of any organisation you know.
- Investment risk and diversification

Supply management is also known as procurement at many firms and government


agencies, justify the statement

Explain totally the concept of supply chain management and logistics management,
show the basis for comparism and major differences between the concepts

Management decision as regard cost is very essential, evaluate the important of


relevant and marginal costing strategies of management of any supply chain
management firm

What constitute differentiation in the value chains analysis of a supply chain


organisation, state ways this could be achieved by the supply chain managers?
Enumerate all the main short-terms investment vehicle characteristics you know and
explain them

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