A food manufacturer uses approx. 50,000 glass jars a month for the one of its pr
ID: 395069 • Letter: A
Question
A food manufacturer uses approx. 50,000 glass jars a month for the one of its products. A lot size of 5,000 jars has been used. Annual holding cost is $2.00 per jar, and ordering cost is $350.00 per order. A. What penalty is the company incurring by using its present order size rather than the EOQ model? B. The manager would prefer ordering 50 times each year but would have to justify and change in order size. One possibility is to simplify order processing to reduce the ordering cost. What ordering cost would enable the manager to justify ordering 50 times per year? C. Suppose that after investigating ordering cost, the manager is able to reduce it to $300. How else could the manager justify using an order size that would be consistent with ordering 50 times per year?
Explanation / Answer
ANSWER TO QUESTION # a :
Following are the relevant details for calculation of Economic Order Quantity ( EOQ ) :
Annual demand = D = 50,000 jars/ month x 12 months = 600,000 Jars
Ordering cost = Co = $350
Annual unit holding cost = Ch = $2
Therefore, economic order quantity ( EOQ )
= Square root ( 2 x Co x D / Ch )
= Square root ( 2 x 350 x 600,000/ 2 )
= 14491.37 ( 1449 rounded to nearest whole number )
Following are inventory related costs at EOQ = 14491 :
Annual ordering cost = Co x D/EOQ = $ 350 x 600,000/14491 = $14491.75
Annual inventory holding cost = Ch x EOQ/2 = $2 x 14491/2 = $14491
Total inventory cost = $14491.75 + $ 14491 = $28982.75
Following are inventory related costs at order quantity = 5000 jars:
Annual ordering cost = Co x D / Order quantity = $350 x 600,000 /5,000 = $42,000
Annual inventory holding cost = Ch x Order quantity / 2 = $ 2 x 5000/2 = $ 5,000
Total inventory cost = $42,000 + $5,000 = $ 47,000
Therefore penalty company is incurring by using order size of 5000 jars
= Total inventory cost for order quantity of 5000 jars – Total inventory cost for order quantity of 14491 jars
= $47,000 - $28982.75
= $18017.25
Answer to question # b :
Required order quantity for ordering 50 times a year
= Annual demand/ 50
= 600,000/50
Thus revised economic order quantity ( EOQ ) = 12,000
Let , relevant ordering cost = $N
Since ,
EOQ = Square root ( 2 x Ordering cost x Annual demand/ Annual unit inventory holding cost )
Therefore ,
12,000 = Square root ( 2 x N x 600,000 / 2)
Or, 12,000 = Square root ( 600,000.N)
Or, 12,000 x 12,000 = 600,000 x N
Or, N = ( 12,000 x 12,000/ 600,000)
Or, N = 240
ORDERING COST OF $240 WOULD JUSTIFY THE MANAGER ORDERING 50 TIMES A YEAR
Answer to question # c :
As it is evident from the formula of EOQ , EOQ is :
Thus , to maintain an EOQ of 12,000 ( i.e ordering 50 times a year ) besides reducing ordering cost from $350 to $240, manager could also increase annual unit inventory holding cost
ORDERING COST OF $240 WOULD JUSTIFY THE MANAGER ORDERING 50 TIMES A YEAR
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