Chapter 5 Inventory Management

Answer Key

I. TRUE OR FALSE STATEMENTS Black - True; Red - False

1. The financial manager’s general disposition toward inventory levels is to keep them low, to ensure that
the firm’s money is not being unwisely invested in excess resources.
2. The Economic Order Quantity (EOQ) Model is an inventory management technique for determining an
item’s optimal order size
3. Ordering costs are the variable costs per unit of holding an item in inventory for a specific period.
4. The safety stock is the point at which to reorder inventory, expressed as days of lead time  daily usage.
5. As the inventory turnover ratio increases, the inventory conversion cycle increases.
6. Firms should hold the maximum amounts of inventories that will ensure productions schedules or the
satisfaction of customer expectations.
7. The reorder point is an inventory management system that compares production needs to available
inventory balances and determines when orders should be placed for various items on a firm's bill of
materials.
8. Safety stock is used as a buffer against unexpected increases in demand, uncertainty about lead time, and
unavailability of stock from suppliers.
9. Enterprise resource planning (ERP) is an inventory management technique that minimizes inventory
investment by having materials arrive at exactly the time they are needed for production.
10. A materials requirement planning (MRP) system is an inventory management technique that applies EOQ
concepts and a computer to compare production needs to available inventory balances and determine
when orders should be placed for various items on a product’s bill of materials.
11. A purchasing manager would purchase higher inventories when prices are low and lower inventories
when prices are high irrespective of inventory requirement.
12. A marketing manager would like to have smaller inventories of finished products to ensure production of
goods as per customer specification.
13. A financial manager would keep inventory levels low to ensure that the firm's money is not unwisely
invested in excess resources
14. A manufacturing manager would keep raw materials inventories low to ensure use of latest materials in
production process.
15. Because its objective is to maximize inventory investment, a JIT system uses no (or very little) safety stock.
16. In a JIT system, extensive coordination among the firm’s employees, its suppliers, and shipping companies
must exist to ensure that material inputs arrive on time.
17. The costs of goods acquired from suppliers including incoming freight or transportation costs are called
purchasing costs.
18. Firms should hold the maximum amounts of inventories that will ensure productions schedules or the
satisfaction of customer expectations.
19. The economic-order-quantity decision model takes into account occurrence of stockouts.
20. As the inventory turnover ratio increases, the inventory conversion cycle increases.
21. In EOQ model, the average inventory is defined as the order quantity divided by 2.
22. In the EOQ model, the total cost is minimized at the point where the order costs and carrying costs are
equal.
23. The reorder point is an inventory management system that compares production needs to available
inventory balances and determines when orders should be placed for various items on a firm's bill of
materials.
24. Safety stock is used as a buffer against unexpected increases in demand, uncertainty about lead time, and
unavailability of stock from suppliers.
25. The objective for managing inventory is to improve the average collection period without affecting the
sales
II. MULTIPLE CHOICE QUESTIONS Encircle the letter that corresponds to the best answer

1. Assuming demand is deterministic, what is the essence of the economic order quantity model for
inventory?
a. To minimize order costs or carrying costs and maximize the rate of inventory turnover.
b. The minimize order costs or carrying costs, whichever is higher.
c. To order sufficient quantity to economically meet the next period's demand.
d. To minimize the total order costs and carrying costs.

2. Which of the following is a relevant factor in the determination of an economic order quantity?
a. Physical plant insurance costs.
b. Warehouse supervisory salaries.
c. Variable costs of processing a purchase order.
d. Physical plant depreciation charges.

3. The estimates necessary to compute the economic order quantity are

a. Annual usage in units, cost per order, and annual cost of carrying one unit in stock.
b. Annual usage in units, cost per unit of inventory, and annual cost of carrying one unit in stock.
c. Annual cost of placing orders, and annual cost of carrying one unit in stock.
d. Cost of placing orders and carrying cost.

4. What effect, if any, will a last-in, first-out inventory method have on economic order quantity (EOQ)?
a. No effect
b. LIFO will reduce the order quantity in times of rising prices.
c. LIFO will increase the order quantity in times of rising prices.
d. FIFO will increase the order quantity in times of rising prices.

5. A company buys a certain part for its manufacturing process. In order to determine the optimum size of a
normal purchase order, the formula for the economic order quantity (EOQ) is used. In addition to the
annual demand, what other information is necessary to complete the formula?
a. Cost of placing an order, and annual cost of carrying a unit in stock.
b. Cost of the part, and annual cost of carrying a unit in stock.
c. Cost of placing an order.
d. Cost of the part.

6. For inventory management, ignoring safety stocks, which of the following is a valid computation of the
reorder point?
a. The economic order quantity.
b. The economic order quantity multiplied by the anticipated demand during the lead-time.
c. The anticipated demand during the lead-time.
d. The square root of the anticipated demand during the lead-time.

7. Which of the following could be determined by using the economic order quantity formula?
a. Optimum size of a production run
b. Safety-stock
c. Stock-out cost
d. Order point

8. The order size determined by the economic order quantity formula minimizes the annual inventory cost
which is comprised of ordering costs and
a. Safety-stock cost
 b. Stock-out cost
c. Set-up cost
d. Carrying cost

9. For its economic order quantity (EOQ) model, a company has a cost of placing an order equal to P10, and
an annual cost of carrying one unit in stock equal to P2. If the cost of placing an order increases by 20%
and the annual cost of carrying one unit in stock increases by 25% and all other considerations remain
constant, the EOQ will
a. Remain unchanged
b. Increase
c. Decrease
d. Either increase or decrease depending on the reorder point.

10. Uncertainty regarding product demand and delivery time for replenishing stock affects the size of a safety
stock inventory. In this regard, which of the following statements are correct?
i. The more certain is the delivery time for replenishing stock, the more safety stock is needed.
ii. The less certain is the delivery time for replenishing stock, the more safety stock is needed.
iii. The more certain is product demand, the more safety stock is needed.
iv. The less certain is product demand, the more safety stock is needed.

a. i and iii
b. i and iv
c. ii and iii
d. ii and iv

11. With regard to the optimal order quantity (Q*), which of the following statements are correct?
i. As carrying cost per unit increases, Q* increases.
ii. As total demand over the planning period increases, Q* increases.
iii. As ordering cost per unit increases, Q* increases.

a. i only
b. ii and iii
c. ii only
d. i, ii, and iii

12. The ________ is the time period that elapses from the point when a firm uses the raw materials in
manufacturing a finished good to the point when the finished good is sold.
a. cash turnover
b. cash conversion cycle
c. average age of inventory
d. average collection period

13. A firm may have a negative cash conversion cycle if it carries ________.
a. high inventory and sells its products for cash
b. high inventory and sells its products on credit
c. very little inventory and sells its products for cash
d. very little inventory and sells its products on credit

14. Jae Co. uses the economic order quantity (EOQ) model for inventory management. A decrease in which
one of the following variables would increase the EOQ?
a. Annual sales.
 b. Cost per order.
c. Safety stock level.
d. Carrying costs.

15. The level of safety stock in inventory management depends on all of the following except the
a. Cost to reorder stock.
b. Cost of running out of inventory.
c. Level of uncertainty of the sales forecast.
d. Level of customer dissatisfaction for back orders.

16. The objective for managing inventory is to ________.

a. improve the average collection period without affecting the sales
b. turn over inventory as quickly as possible without losing sales from stockouts
c. make payment for the inventory as slowly as possible without losing suppliers
d. reduce the time taken to process inventory into finished goods and increase sales

17. ABC Company has correctly computed its economic order quantity at 1,000 units; however, management
feels it would rather order in quantities of 1,500 units. How should ABC’s total annual purchase order cost
and total annual carrying cost for an order quantity of 1,500 units compare to the respective amounts for
an order quantity of 1,000 units?
a. Lower purchase order cost and lower carrying cost
b. Lower purchase order cost and higher carrying cost
c. Higher purchase order cost and higher carrying cost
d. Higher purchase order cost and lower carrying costs

18. ABC Company has correctly computed its economic order quantity at 500 units; however, management
feels it would rather order in quantities of 450 units. How should ABC’s total annual purchase order cost
and total annual carrying cost for an order quantity of 450 units compare to the respective amounts for an
order quantity of 500 units?
a. Lower purchase order cost and lower carrying cost
b. Lower purchase order cost and higher carrying cost
c. Higher purchase order cost and higher carrying cost
d. Higher purchase order cost and lower carrying costs

19. The amount of inventory that a company would tend to hold in stock would increase as the
a. variability of sales decreases.
b. cost of carrying inventory decreases
c. cost of running out of stock decreases
d. sales level falls to a permanent lower level

20. To evaluate the efficiency of purchase transactions, management decides to calculate the economic order
quantity for a sample of the company’s products. To calculate the economic order quantity, management
would need data for all of the following, except
a. the volume of production sales.
b. the purchase prices of the products.
c. the fixed cost of ordering products.
d. the volume of products in inventory.

III. MULTIPLE CHOICE PROBLEMS Encircle the letter that corresponds to the best answer.

1. Sterling Clips, Inc. estimates that it will sell 10,000 porcelain clips next year. Because porcelain clips are so
 easily damaged, the average per-unit carrying cost of the clips is P10. The per-order cost of ordering is P250.
Assume that Sterling wants a safety stock of 200 clips. If Sterling reorders the clips based on the economic
order quantity, what is Sterling’s average inventory of porcelain clips (round to the nearest 10 clips)?
a. 350
b. 450
c. 550
d. 650

2. One Shade Company will use an estimated 50,000 units in its manufacturing process next year. The
carrying cost of inventory is P.04 per unit, and the cost of reordering is P50 per order. What is the company’s
economic ordering quantity (round to the nearest 100 units)?
a. 11,200
b. 10,700
c. 9,700
d. 8,100

3. Auto Builders Corporation uses semi-hex joints in its manufacturing process. If the company’s total
demand for the joints for next year is estimated to be 15,000 units, and if the cost per order is P80, what is
the company’s economic order quantity? Assume that carrying costs for semi-hex joints are P.51 per unit
and round off to the nearest 100 units.
a. 1,600
b. 1,800
c. 2,000
d. 2,200

4. Wheels Company will use an estimated 4,000-wheel assemblies in its manufacturing process next year. The
carrying cost of the wheel assembly inventory is P0.60 per wheel, and the ordering cost per order is P20.
What is the economic ordering quantity of wheel assemblies (round to the nearest unit)?
1. 215
2. 365
3. 417
4. 516

5. Carter Company buys raw materials for its manufacturing process for P20 a part. Ten thousand parts a
year are needed. It costs P8 a year to carry one of these parts in inventory. The cost of placing a purchase
order for these parts is P10. Assuming that the parts will be required evenly throughout the year, the
formula for the economic order quantity is

a. 2 x 10,000 x 8
10

b. 2 x 10,000 x 10
8

c. 10,000 x 8
10

d. 10,000 x 10
8
6. The Aaron Company requires 40,000 units of Product Q for the year. The units will be required evenly
throughout the year. It costs P60 to place an order. It costs P10 to carry a unit in inventory for the year.
What is the economic order quantity?
 a. 400
b. 600
c. 693
d. 490

7. Politan Company manufactures bookcases. Setup costs are P2. Politan manufactures 4,000 bookcases
evenly throughout the year. Using the economic order quantity approach, the optimal production run
would be 200 when the cost of carrying one bookcase in inventory for one year is
a. P0.05
b. P0.10
c. P0.20
d. P0.40

8. Garmar, Inc. has determined the following for a given year:

EOQ(standard order size) 5,000 units
Total cost to place purchase orders for the year P10,000
Cost to place one purchase order P50
Cost to carry one unit for one year P4

What is Garmar's estimated annual usage in units?

a. 1,000,000
b. 2,000,000
c. 4,000,000
d. 3,000,000

9. Barter Corporation had been buying Product A in lots of 1,200 units which represents a four month's
supply. The cost per unit is P100; the order cost is P200 per order; and the annual inventory carrying cost
for one unit is P25. Assume that the units will be required evenly throughout the year. What is the
economic order quantity?
a. 144
b. 240
c. 600
d. 1,200

For the next 3 items:

Neggie Corp has a secret ingredient in its production. This ingredient costs the company P60 each from the
supplier and requires a 6-day lead time. The demand every quarter is 13,680 units. The ordering cost is P12.50 per
order. (EOQ is 1200 units)

10. The carrying cost per unit is

a. P0.24
b. P0.95
c. P0.71
d. P0.48

11. The desired safety stock if the maximum daily usage is 175 units is
a. 138 units
b. 822 units
c. 912 units
d. 1,050 units
 12. The total inventory cost amounts to
a. P288
b. P426
c. P576
d. P1,140

13. The General Chemical Company uses 150,000 gallons of hydrochloric acid per month. The cost of carrying
the chemical in inventory is 50 cents per gallon per year, and the cost of ordering the chemical is P150 per
order. The firm uses the chemical at a constant rate throughout the year. The chemical’s economic order
quantity is
a. 32,863 gallons
b. 11,619 gallons
c. 9,487 gallons
d. 1,900 gallons

14. The General Chemical Company uses 150,000 gallons of hydrochloric acid per month. The cost of carrying
the chemical in inventory is 50 cents per gallon per year, and the cost of ordering the chemical is P150 per
order. The firm uses the chemical at a constant rate throughout the year. It takes 18 days to receive an order
once it is placed. The reorder point is
a. 7,500 gallons
b. 25,000 gallons
c. 90,000 gallons
d. 105,000 gallons

15. The General Chemical Company uses 150,000 gallons of hydrochloric acid per month. The cost of carrying
the chemical in inventory is 50 cents per gallon per year, and the cost of ordering the chemical is P150 per
order. The firm uses the chemical at a constant rate throughout the year. It takes 18 days to receive an order
once it is placed. If the maximum usage is 162,000 gallons per month, the safety stock is
a. 625 gallons
b. 7,200 gallons
c. 8,125 gallons
d. 97,200 gallons

PROBLEMS

5.1
The ReignLyn Tags Company produces a luggage and bag tag product, and has the following information
available concerning its inventory items:

Annual demand - 50,000 units per year

Purchase price - ₱35 per package
Ordering costs - ₱250 per purchase order
Carrying costs - 10% of purchase price plus: ₱4.50

Required:

1. What is the economic order quantity? (round-off final answer in whole units)
2. What are the total relevant costs at the economic order quantity? (use EOQ rounded-off to 5 d.p.; total relevant
costs round-off to 2 decimal places)
3. What are the total relevant costs, assuming the quantity ordered equals 1,000 units?
 Answers:
2D0 2 (50,000) 250
1. EOQ = √ EOQ = √10% X (35)+ 4.5
C

EOQ = 1,768 units

2.
Ordering Costs = O x S / EOQ
Ordering Costs = ₱250 x 50,000 = ₱7,071.07
1,767.76695
Carrying Costs = C x EOQ / 2
Carrying Costs = ₱8 x 1,767.76695 = ₱7,071.07
2
Total Relevant Costs ₱14,142.14

3.
Ordering Costs = O x S / OQ
Ordering Costs = ₱250 x 50,000 = ₱12,500.00
1,000
Carrying Costs = C x OQ / 2
Carrying Costs = ₱8 x 1,000 = ₱4,000.00
2
Total Relevant Costs ₱16,500.00

5.2
ABC Company sells 20,000 units of radio evenly throughout the year. The cost of carrying one unit in
inventory for one year is P8, and the purchase order cost per order is P32.

Required:

1. What is the company’s economic order quantity (EOQ)? 400 units

2. How much is the total ordering and carrying cost using the EOQ? P3,200
3. How much is the total ordering and carrying cost if the company’s order size is at 500 units? P3,280

5.3

XYZ Co. has determined the following for the coming period:
Total ordering and carrying cost using the standard order size (EOQ) P80,000
Cost to carry one unit P16
Cost to place one purchase order P100

Required:

1. What is the entity’s economic order quantity (EOQ)? 5,000 units

2. What is the entity’s estimated annual usage in units? 2,000,000 units
5.4

Yana Corp’s monthly material requirement used in production is 4,050 units. This material costs P180 per
unit for a supplier and it requires 5 days lead time from the date of order to date of delivery. The ordering cost is
P120 per order and the carrying cost is 8% of inventory investment per unit. (Use 360 days).

Determine the following:

1. EOQ 900 units

2. Frequency of order 6.67 days
3. Total inventory cost P12,960
4. Reorder point 675 units
5. Reorder point if maximum daily usage is 150 units 750 units
6. Safety stock 75 units

5.5

RCR Company has a secret ingredient in its production. This ingredient costs the company P60 each from
the supplier and requires 5-day lead time. The ordering cost is P25 per order and the carrying cost per unit is 10%
of purchase price. (EOQ is 2,400 units). Use 360 days

Determine the following:

1. Annual demand 691,200 units

2. Frequency of order 1.25 days
3. Total inventory cost P14,400
4. Reorder point 9,600 units
5. Reorder point if maximum daily usage is 1,200 units (maximum daily usage is 2,000 units instead of 1,200
units) Answer is 10,000 units
6. Safety stock 400 units

5.6
In its 2017 annual report, Racquel Corporation reported that it had revenues of P19.2 billion, cost of goods
sold of P16.8 billion, accounts receivable of P2.4 billion, inventory of P2.1 billion and accounts payable of P1.25
billion. Total purchases for the year was P11.25 billion. Use 360 days
Required:
1. What is the average age of inventory? 45 days
2. What is the amount of resources invested in inventory? P2.1 billion
3. Determine the cash conversion cycle. 50 days

5.7 NONE
 5.8 1 Average inventory = Order size / 2
using EOQ as the order size 200 boxes / 2 = 100
the question was the average held during the year, so, 200 x 50 times of order = 5,000 boxes

2 EOQ = 2 x annual demand x ordering costs

Carrying costs

EOQ = 2 X 10,000 X P10 = 200.00 boxes

P5.00

3 Number of orders = Demand / order size

10,000 boxes / 200 boxes = 50 times

5.9
1 EOQ = 2 X 50 X P15 = 17 sets
15.00

2 lead time is one week 50 weeks in a year, 1 unit per week

Order point = daily demand x lead time + safety stock
OP = 1 unit per week x 2 weeks + 1 week safety stock =
= 2 +1 = 3 sets

5.10
1 EOQ = 2 X 500,000 X P1,000 = 47,673 lbs
20% x P2.20

2 Number of orders 500,000 / 47,673 = 10.488 orders

3 Average inventory (47,673 / 2 ) + 20,000 = 43,836

4 Reorder point = Average daily sales x lead time + safety stock =

(500,000 / 365) x 10 days + 20,000 = 33,699

5 Total inventory costs (total carrying and ordering costs) = Total Carrying costs + Ordering costs
Carrying costs = Average inventory x carrying costs per unit
Ordering costs = number of orders x cost per order
[43,836 x (20% x P2.20) ] + (10 x P1,000) =
P19,287.84 + P10,000 = 29,288
5.11
1 EOQ = 2 X 2,000 X P8 = 462
0.15

2 Ordering costs if once a year = P8

3 Ordering costs if four times a year = 4 x P8 = 32

5.12
1 EOQ = 2 X 2,000 X P10 = 200
1.00

2 Number of orders 10
3 Reorder point 40 units

5.13
1 EOQ = 2 x annual demand x ordering costs
Carrying costs

EOQ = 2 X 2,600,000 X P5,000 = 509,902.00 kilos

P5.00 x .02

since the order is multiples of 2,000, the company must order 510,000 kilos

2 average weekly sales = 2,600,000 / 52 weeks = 50,000.00 kilos

reorder point = 6 week's sales + safety stock
6 x 50,000 + 200,000 500,000.00 kilos

3 total inventory costs and carrying cost of safety stock:

TIC = [(2%) X(P5) X (510,000/2)] + (P5,000) X (2,600,000/510,000) +(.02) X (P5)(200,000)
= 25,500.00 + 25,500.00 + 20,000.00
= 71,000.00

4 Ordering costs would be reduced by P3,500 to P1,500. By ordering 650,000 kilos at a time,
the firm can braing its total inventory cost to P58,500
= (.02)(P5) (650,000/2) + (P1,500)(2,600,000/650,000)+(.02)(P5)(200,000)
= 32,500.00 6,000.00 20,000.00
= 58,500.00

Because the firm can reduce its total inventory costs by ordering 650,000 kilos at a time, it
should accept the offer and place large orders.
 5.14
1 EOQ = 2 x annual demand x ordering costs
Carrying costs

EOQ = 2 X 36,000 X P100 = P7,200 / 24 548 dozens

P24.00

2 Inventory costs = Ordering costs + carrying costs

36,000 / 800 size per order = 45 orders
Ordering costs = 45 x P100 = 4,500.00
Carrying costs = [(800 / 2) x P24] = 9,600.00
Total inventory costs PPPP 14,100.00

3 Reorder point = Daily demand x lead time

Daily demand = Annual demand / working days
36,000 / 300 in units 120.00
Reorder point = 120 x 3 days in units 360.00

5.15
order sizes in dozens 26 50 100 130 200 2600
number of orders 100 52 26 20 13 1
average inventory 13 25 50 65 100 1300
carrying cost 39.00 75.00 150.00 195.00 300.00 3,900.00
ordering cost 700.00 364.00 182.00 140.00 91.00 7.00
total cost 739.00 439.00 332.00 335.00 391.00 3,907.00

5.16
1 Safety stock
Average monthly usage 780 units / 12 months = 65.00
Maximum usage 80.00
a Difference 15.00
b Lead time in months 1.00
(a x b) Safety stock (safety stock could be the difference 15.00
of average usage and maximum usage x lead time)

2 Reorder point = (monthly demand x lead time) + safety stock

65 x 1 month = 65 + 15 = 80.00
Note: Since maximum usage is given, reorder point will be the maximum usage
x the lead time which is one month, so we could take it just from there.
 5.17
1 Annual cost of ordering = (Annual demand / order quantity ) x cost per order
Annual carrying cost = (Order quantity/ 2) x Annual carrying cost per unit

2 EOQ = 2 x D x CO
CU

= 2 x 4,800 x P150
P4.00
= 600

3 Total annual carrying and ordering costs

Ordering = (4,800 / 600) x P150 = 1,200.00
Carrying = (600/2) x P4.00 = 1,200.00
Total annual carrying and ordering costs 2,400.00

4 Number of orders per year

= 4,800 / 600 = 8 times

5 using the new cost data

a EOQ = 2 x D x CO
CU

= 2 x 4,800 x P20 = 100

P19.20

b Number of orders per year = 4,800 / 100 = 48 times

5.18
Inventory ordering and carrying costs table
Order sizes 400 600 800.00
Numer of orders per year at 4,800 demand 12 8 6.00
a Ordering costs at P150 per order 1,800.00 1,200.00 900.00
Average inventory (order size / 2) 200 300 400.00
b Carrying costs at P4.00 per unit 800.00 1,200.00 1,600.00
(a +b) Total ordering and carrying costs 2,600.00 2,400.00 2,500.00
 Cost Number Total Carryng
5.19 Stock per of stockout cost per
levels Probability x stock orders cost unit
10 0.50 x 80.00 5 200.00 2.00
20 0.40 x 80.00 5 160.00 2.00
30 0.30 x 80.00 5 120.00 2.00
40 0.20 x 80.00 5 80.00 2.00
50 0.10 x 80.00 5 40.00 2.00
55 0.05 x 80.00 5 20.00 2.00

Safety stock level 55 showed the lowest stockout and carrying cost.

Total CC
Total Carrying Cost and Stockout
SS ( SS x CC /unit) cost
10 20.00 220.00
20 40.00 200.00
30 60.00 180.00
40 80.00 160.00
50 100.00 140.00
55 110.00 130.00

5.20
At current policy At proposed
Sales 810,000.00 850,500.00 P810,000 x 1.05
CMR 0.35 0.35
Contribution margin 283,500.00 297,675.00
Less, bad debts exp. 8,100.00 11,907.00
Net income before
cost of money on
uncollected accounts 275,400.00 285,768.00
Less 25% on uncollected
accounts * 22,500.00 30,375.00
NET INCOME 252,900.00 255,393.00

The company must adopt the new policy, quantitatively it increased its net income.

* Cost of money computed as follows:

Ave. A/R = 810,000.00 Ave. A/R = 850,500.00
9 times TO 7 times TO
90,000.00 121,500.00
Desired rate of return 0.25 Desired rate of return 0.25
Cost of money 22,500.00 Cost of money 30,375.00