1. Tom’s Gift Shop is experiencing some inventory control problems. Tom currentl

Question

1. Tom’s Gift Shop is experiencing some inventory control problems. Tom currently orders 5,000 units 5 times each year to handle annual demand of 25,000 units. Each order costs $15 and each unit costs $1.00 to carry. Tom maintains a safety stock of 200 units.
(a) What is Tom’s Gifts' current total annual inventory cost?

(b) Calculate the economic ordering quantity (EOQ).

(c) What is average inventory under EOQ if Tom maintains a safety stock of 200 units.

(d) Calculate total annual inventory cost under EOQ.

Explanation / Answer

Answer a Tom’s Gifts' current total annual inventory cost = Ordering cost + Carrying cost Inventory Ordering cost = 5 orders * $15 = $75 Inventory Carrying Cost = Average Inventory * Carrying cost per unit = [(200 units+5000 units)/2]*$1 = $2600 Tom’s Gifts' current total annual inventory cost = $75 + $2600 = $2675 Answer b Calculation of the economic ordering quantity EOQ = SQRT(2 × Annual Quantity × Cost Per Order / Carrying Cost Per unit) EOQ = SQRT(2 × 25000 units × $15 / $1) EOQ = SQRT(750000) EOQ = 866 units Answer c Average inventory under EOQ if Tom maintains a safety stock of 200 units = (Safety stock + EOQ)/2 = (200 units+866 units)/2 = 533 units Answer d Calculation of total annual inventory cost under EOQ. Total annual Inventory cost under EOQ = Ordering cost + Carrying cost Inventory Ordering cost = (25000 units / 866 units)*$15 per order = $433.03 Carrying cost = Average inventory under EOQ * Carrying Cost per unit = 533 units * $1 = $533 Total annual Inventory cost under EOQ = $433.03 + $533 = $966.03

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