Groundz Coffee Shop uses 4 pounds of a specialty tea weekly; each pound costs $1
ID: 454975 • Letter: G
Question
Groundz Coffee Shop uses 4 pounds of a specialty tea weekly; each pound costs $16. Carrying costs are $0.25 per pound. It costs the firm $8 to prepare an order. Assume the basic EOQ model with no shortages applies. Assume 52 weeks per year. How many pounds should Groundz order at a time? What is total annual cost (excluding item cost) of managing this item on a cost-minimizing basis? What is the annual ordering cost? Annual holding cost? Why are they equal? The current practice is to order for one week of demand (4pounds). Which cost will go up and which cost will go down and why?Explanation / Answer
Given data:
Annual Demand of Tea (4 × 52) = 208
Ordering Cost = $8.00
Holding Cost = $0.25
a.
Calculate the EOQ:
EOQ = 2AO ÷ H
Here A = Annual Demand
O = Ordering Cost per order
H = Holding Cost per unit per annum
Now, substitute the given values in the formula:
EOQ = 2AO ÷ H = (2 × 208 × 8) ÷ 0.25 = 115.3776
b.
Total Holding Cost (Average Inventory × Holding Cost per unit) (EOQ ÷ 2 × $0.25) = $14.42
Total Ordering Cost (No of orders × Ordering Cost) (Annual Demand ÷ EOQ × 8) = $14.42
Total Cost of Managing Inventory = Total Holding Cost + Total Ordering Cost = $14.42 + $14.42 = $28.84.
c.
Total Holding Cost (Average Inventory × Holding Cost per unit) (EOQ ÷2 × $0.25) = $14.42
Total Ordering Cost (No of orders × Ordering Cost) (Annual Demand ÷ EOQ × 8) = $14.42
At EOQ, both holding cost and ordering cost are lowest and equal which minimizes the annual inventory cost. This makes EOQ the optimum order quantity.
d.
Current Order Size = 2 weeks demand = 2 × 4 = 8 units
No of Orders = 208 ÷ 8 = 26
Ordering Cost = 26 × $ 8 = $208
Carrying Cost = 8÷2 × $0.25 = $1
Ordering Cost will increase and carrying cost will decrease. This is because number of orders increase and the average inventory in hand decreases.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.