Economic order quantity: equation approach; effects of JIT purchasing: manufactu

Question

Economic order quantity: equation approach; effects of JIT purchasing: manufacturer Rally Communications Company manufactures glass fibres used in the communications industry. The company's materials and parts manager is currently revising the inventory ordering policy for XL-20, one of the chemicals used in the production process. The chemical is purchased in 10-kilogram canisters for $190 each. The firm uses 4800 canisters per year. The accountant estimates that the incremental costs of ordering and receiving XL-20 are $300 per order. The annual cost of storing XL-20 is $8 per canister

Required: 1 Use the EOQ formula to determine the optimal order quantity for XL-20. (2 Marks)

2 What is the total annual cost of ordering and storing XL-20 at the economic order quantity? (2 Marks)

3 How many orders will be placed per year? (2 Marks)

4 Rally's accountant, Frank Mallard, recently attended a seminar on JIT purchasing. Afterwards, he analysed the cost of storing XL-20, including the cost of wasted space and inefficiency. He was shocked to find that the real annual carrying cost was $40 per canister. Mallard then met with Doug Kaplan, Rally's purchasing manager. Together they contacted Chemical Industries, the supplier of XL-20, about a JIT purchasing arrangement. After some discussion and negotiation, Kaplan concluded that the cost of placing an order for XL-20 could be reduced to just $60.

(a) Calculate the new EOQ for XL-20. (2 Marks)

(b) How many orders will be placed per year? (2 Marks)

Explanation / Answer

1.EOQ = SQRT(2 × Quantity × Cost Per Order / Carrying Cost Per Order)

=SQRT(2*4800*300/8)

= 600 canisters

2.Annual demand is 4,800 canisters so the company will have to place 8 orders (= annual demand of 4800 divided by order size of 600). Total ordering cost is hence $2400 ($300 multiplied by 8).

Totla Storing cost =$ 38,400(4800*8)

3.No. of orders will be placed per year = 8 orders

a) New EOQ for XL-20 =Squre root of (2*4800*60/40)

=120 canisters

b) No .of Orders = 40 orders ( 4800/120)

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