Effect of management evaluation criteria on EOQ model. Computers 4 U purchases o
ID: 2427219 • Letter: E
Question
Effect of management evaluation criteria on EOQ model. Computers 4 U purchases one model of computer at a wholesale cost of $200 per unit and resells it to end consumers. The annual demand for the companyâ??s product is 500,000 units. Ordering costs are $800 per order and carrying costs are $50 per computer, including $20 in the opportunity cost of holding inventory.
Required
1. Compute the optimal order quantity using the EOQ model.
2. Compute a) the number of orders per year and b) the annual relevant total cost of ordering and carrying inventory.
3. Assume that when evaluating the manager, the company excludes the opportunity cost of carrying inventory. If the manager makes the EOQ decision excluding the opportunity cost of carrying inventory, the relevant carrying cost would be $30 not $50. How would this affect the EOQ amount and the actual annual relevant cost of ordering and carrying inventory?
4. What is the cost impact on the company of excluding the opportunity cost of carrying inventory when making EOQ decisions? Why do you think the company currently excludes the opportunity costs of carrying inventory when evaluating the managerâ??s performance? What could the company do to encourage the manager to make decisions more congruent with the goal of reducing total inventory costs?
Explanation / Answer
1)EOQ = Square root of [(2*500,000*800)/50]
= Square root of 16000,000
= 4000 units
.
2)a) the number of orders per year = 500,000/4,000
= 125 orders
..
Average Inventory = 4000/2 = 2000 units
..
b)the annual relevant total cost of ordering and carrying inventory = 125*800 + 2000*50
= $200,000
..
3)If carrying cost per unit is 30 ,
New EOQ = Square root of [(2*500,000*800)/30]
= Square root of 26666666.67
= 5164 units
..
The new annual relevant total cost of ordering and carrying inventory = (500,000/5164)*800 + (5164/2)*30
= 77,460 + 77460
= $154,920
..
4)What is the cost impact on the company of excluding the opportunity cost of carrying inventory when making EOQ decisions
Ans)Reduce in total inventory cost from $200,000 to $154,920
..
Why do you think the company currently excludes the opportunity costs of carrying inventory when evaluating the managerâ??s performance?
Ans)To give more incentive to them.
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