A parts distributor has an annual demand for machine parts of 10,000 per year wi
ID: 376406 • Letter: A
Question
A parts distributor has an annual demand for machine parts of 10,000 per year with average cost of $10 per unit. There are two options for shipping this from Kuala Lumpur, Malaysia, (1) a combination of ship and train that will take 30 days at a cost of $3 per unit or (2) a combination of ship and truck that will take 20 days at a cost $4 per unit. The holding cost rate is 30% of unit cost per year.
a. Which mode of transportation is more economical? (round to the nearest dollar)
b. Would your answer change if the parts distributor keeps a safety stock of 100 units for option (1) and a safety stock of 50 units for option (2) (round to the nearest dollar)?
Explanation / Answer
Answer to question a :
Freight cost under option 1 = $ 3/ unit x 10000 unit = $ 30,000
Freight cost under option 2 = $4/ unit x 10,000 = $40,000
In transit inventory holding cost under any option
= 10,000 units x $10/ unit x 0.3 ( i.e.holding cost rate) x Transit days/ 365 days
= 30000/365 x Transit days
Therefore In- transit inventory holding cost under option 1 with 30 days transit time = 30,000 x 30/365 = $2465.75
In transit inventory holding cost under option 2 with 20 days transit time = 30,000 x 20/365 = $1643.83
Total cost = Freight cost + In transit inventory holding cost
Hence,
Total cost under option 1 = $30,000 + $2465.75 = $32465.75 ( $32466 rounded to nearest Dollar)
Total cost under option 2 = $40,000 + $1643.83 = $41643.83 ( $41644 rounded to nearest Dollar)
Therefore option 1 i.e. combination of ship and train is more economical
COMBINATION OF SHIP AND TRAIN IS MORE ECONOMICAL
Answer to question b :
Value of safety stock under option 1 = 100 units x $10/ unit = $1,000
Value of safety stock under option 2 = 50 units x $10/ unit = $500
Annual holding cost for safety stock under option 1 ( @ 30 % of value ) = 0.30 x $1000 = $300
Annual holding cost for safety stock under option 2 ( @ 30% of value ) = 0.30 x $500 = $150
Total cost under any option = Freight cost + In transit inventory cost + Annual safety stock holding cost
Therefore ,
Total cost under option 1 = $32466 + $300 = $32766
Total cost under option 2 = $41644 + $150 = $41794
Option 1 i..e. combination of ship and train is still more economical
THE ANSWER WOULD NOT CHANGE
COMBINATION OF SHIP AND TRAIN IS MORE ECONOMICAL
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