7.5 Inventory Management Flashcards
(16 cards)
Which one of the following statements concerning the economic order quantity (EOQ) is correct?
A. The EOQ results in the minimum ordering cost and minimum carrying cost.
B. Increasing the EOQ is the best way to avoid stockouts.
C. The EOQ model assumes constantly increasing usage over the year.
D. The EOQ model assumes that order delivery times are consistent.
D. The EOQ model assumes that order delivery times are consistent.
One of the underlying assumptions of the EOQ model is that delivery times are predictably consistent. Other assumptions are that sales are perfectly predictable and that usage is constant.
The amount of inventory that a company would tend to hold in safety stock would increase as the
A. Sales level falls to a permanently lower level.
B. Cost of carrying inventory decreases.
C. Variability of sales decreases.
D. Cost of running out of stock decreases.
B. Cost of carrying inventory decreases.
In inventory management, the safety stock will tend to increase if the
A. Carrying cost increases.
B. Cost of running out of stock decreases.
C. Variability of the lead time increases.
D. Variability of the usage rate decreases.
C. Variability of the lead time increases.
A company maintains safety stocks to protect itself against losses caused by stockouts. These can take the form of lost sales or lost production time. Safety stock is needed because of the variability in lead time and usage rates. As the variability in lead time increases, a company tends to carry larger safety stocks.
The optimal level of inventory is affected by all of the following except the
A. Usage rate of inventory per time period.
B. Cost per unit of inventory.
C. Current level of inventory.
D. Cost of placing an order for merchandise.
C. Current level of inventory.
The optimal level of inventory is affected by the factors in the economic order quantity (EOQ) model and delivery or production lead times. These factors are (1) the periodic demand for inventory; (2) the carrying cost, which includes the interest on funds invested in inventory; (3) the usage rate; and (4) the cost of placing an order or making a production run. The current level of inventory is irrelevant to the optimal inventory level.
A major supplier has offered a corporation a year-end special purchase whereby it could purchase 180,000 cases of sport drink at $10 per case. The corporation normally orders 30,000 cases per month at $12 per case. The corporation’s cost of capital is 9%. In calculating the overall opportunity cost of this offer, the cost of carrying the increased inventory would be
A. $32,400
B. $40,500
C. $64,800
D. $81,000
A. $32,400
If the corporation makes the special purchase of 6 months of inventory (180,000 cases ÷ 30,000 cases per month), the average inventory for the 6-month period will be $900,000 [(180,000 × $10) ÷ 2]. If the special purchase is not made, the average inventory for the same period will be the average monthly inventory of $180,000 [(30,000 × $12) ÷ 2]. Accordingly, the incremental average inventory is $720,000 ($900,000 – $180,000), and the interest cost of the incremental 6-month investment is $32,400 [($720,000 × 9%) × (6 ÷ 12)].
A review of inventories reveals the following cost data for entertainment centers.
Invoice price $400 per unit
Freight and insurance on shipment 20 per unit
Insurance on inventory 15 per unit
Unloading 140 per order
Cost of placing orders 10 per order
Cost of capital 25%
What are the total carrying costs of inventory for an entertainment center?
A. $120
B. $115
C. $420
D. $105
A. $120
The cost of carrying a unit of inventory can be calculated as follows:
Invoice price $400
add) freight and insurance on shipment 20
= per unit purchase cost $420
x cost of capital x 25%
= opportunity cost $105
add) insurance on inventory 15
= per-unit carrying cost $120
An entity uses 400 lbs. of a rare isotope per year. The isotope costs $500 per pound, but the supplier is offering a quantity discount of 2% for order sizes between 30 and 79 lbs. and a 6% discount for order sizes of 80 lbs. or more. The ordering costs are $200. Carrying costs are $100 per pound of material and are not affected by the discounts. If the purchasing manager places eight orders of 50 lbs. each, the total cost of ordering and carrying inventory, including discounts lost, will be
A. $12,100
B. $1,600
C. $4,100
D. $6,600
A. $12,100
Average inventory can be calculated based on the average order size (total order quantity divided by 2). For this entity, that is 50lbs. / 2, which is 25 lbs. for average inventory.
The entity’s annual ordering costs are $1,600 ($200 per order x 8 orders per year), and the annual carrying costs are $2,500 ($100 per pound x 25lbs. average inventory). Gross annual product purchase cost is $200,000 ($500 per pound x 400 lbs. annual usage).
Because the differential discount lost is 4%, annual discounts lost equal $8,000 ($200,000 x 4%). If the purchasing manager places 8 orders of 50 lbs. each, the entity’s total cost can be calculated as follows:
Annual ordering costs $1600
Annual carrying costs 2500
Annual discounts lost 8000
= total cost 12,100
Using the economic order quantity (EOQ) model, a decrease in which one of the following variables would increase the EOQ?
A. Safety stock level,
B. Annual sales.
C. Carrying costs.
D. Cost per order.
C. Carrying Costs.
The EOQ model minimizes the total of ordering and carrying costs. Increase in the demand or ordering cost increase the EOQ, but decreases in these will decrease the EOQ. Similarly, a decrease in carrying costs will increase the EOQ.
A company expects to use 48,000 gallons of paint per year costing $12 per gallon. Inventory carrying cost is equal to 20% of the purchase price. The company uses its inventory at a constant rate. The lead time for placing the order is 3 days, and the company holds 2,400 gallons of paint as safety stock. If the company orders 2,000 gallons of paint per order, what is the cost of carrying inventory?
A. $2,400
B. $8,160
C. $5,280
D. $5,760
B. $8,160
The company’s per-gallon carrying cost is $2.40 ($12 purchase price per gallon x 20% carrying cost). Average inventory can be calculated based on the average order size as the total order quantity divided by the number of orders. Average inventory is 1,000 gallons (2,000 gallons ordered divided by 2 orders). The cost of carrying safety stock is $5,760 (2,400 gallons x $2.40), and the cost of carrying average inventory is $2,400 (1,000 gallons x $2.40). Thus, total inventory carrying cost is $8,160 ($5,760 + $2,400).
A distributor is reviewing its inventory policy with respect to safety stocks of its most popular product. Four safety stock levels were analyzed and annual stockout costs estimated for each level.
Safety Stock / Stockout Costs
1,000 units / $3,000
1,250 units / $2,000
1,500 units / $1,000
2,000 units / $0
The cost of this product is $20 per unit, holding costs are 4% per year, and the cost of short-term funds is 10% per year. What is the optimal safety stock level?
A. 2,000 units
B. 1,500 units
C. 1,000 units
D. 1,250 units
B. 1,500 units
Total cost of safety stock =
purchase price x safety stock level = investment in safety stock
Investment in safety stock x cost of capital = interest cost of safety stock
Per unit holding cost x units held = total holding cost
stock out cost = given
Interest cost of safety stock + Total holding cost + stockout cost = total cost of safety stock
The total cost is lowest when the safety stock is 1,500 units.
The controller at a chain of hardware stores wants to determine the optimum safety stock levels for an air purifier unit. The inventory manager compiled the following data:
- The annual carrying cost of inventory approximates 20% of the investment in inventory
- The inventory investment per unit averages $50
- The stockout cost is estimated to be $5 per unit
- The company orders inventory on the average of 10 times per year
- Total cost = carrying cost + expected stockout cost
- The probabilities of a stockout per order cycle with varying levels of safety stock are as follows:
Safety stock: 200, Resulting stock out: 0, Probability: 0%
Safety stock: 100, Resulting stock out: 100, Probability: 15%
Safety stock: 0, Resulting stock out: 100, Probability: 15%
Safety stock: 0, Resulting stock out: 200, Probability: 12%
The total cost of safety stock on an annual basis with a safety stock level of 100 units is
A. $1,950
B. $2,000
C. $550
D. $1,750
D. $1,750
The cost of safety stock is given as carrying cost plus expected stockout cost. At 20% of the $50 unit inventory cost, carrying cost is $10 per unit per year. Thus, carrying cost for 100 units of safety stock is $1,000. A stockout has a 15% probability at this level of safety stock, and stockout costs are $500 (100 × $5) for each occurrence. If the firm orders 10 times per year, the expected number of stockouts is 1.5 (15% × 10). Hence, total expected stockout cost for the year is $750 ($500 × 1.5). Total cost is $1,750 per year ($1,000 + $750).
All of the following are carrying costs of inventory except
A. Storage costs.
B. Insurance.
C. Opportunity costs.
D. Shipping costs.
D. Shipping costs.
The cost of shipping inventory is a cost of acquiring, not carrying, it.
The result of the economic order quantity (EOQ) formula indicates the
A. Annual quantity of inventory to be carried.
B. Safety stock plus estimated inventory for the year.
C. Quantity of each individual order during the year.
D. Annual usage of materials during the year.
C. Quantity of each individual order during the year.
The EOQ model is a deterministic model that calculates the ideal order (or production lot) quantity given specified demand, ordering or setup costs, and carrying costs. The model minimizes the sum of inventory carrying costs and either ordering or production setup costs.
The new manager of inventory at a major retailer is developing an inventory control system and knows he should consider establishing a safety stock level. The safety stock can protect against all of the following risks except for the possibility that
A. Shipments of merchandise from the manufacturers is delayed by as much as 1 week.
B. The distribution of daily sales will have a large variance due to holidays, weather, advertising, and weekly shopping habits.
C. Customers cannot find the merchandise they want, and they will go to the competition.
D. New competition may open in the company’s market area.
D. New competition may open in the company’s market area.
Safety stock cannot protect against the entry of new competitors.
The level of safety stock in inventory management depends on all of the following except the
A. Level of customer dissatisfaction for back orders.
B. Cost of running out of inventory.
C. Cost to reorder stock.
D. Level of uncertainty of the sales forecast.
C. Cost to reorder stock.
Determining the appropriate level of safety stock involves a complex probabilistic calculation that balances (1) the variability of demand for the good, (2) the variability in lead time, and (3) the level of risk the firm is willing to accept of having to incur stockout costs. Thus, the only one of the items listed that does not affect the level of safety stock is reorder costs.
An example of a carrying cost is
A. Spoilage.
B. Quantity discounts lost.
C. Disruption of production schedules.
D. Handling costs.
A. Spoilage.
Inventory costs consist of four categories: purchase costs, order or set-up costs, carrying (holding) costs, and stockout costs. Carrying costs include storage costs for inventory items plus opportunity cost (i.e., the cost incurred by investing in inventory rather than making an income-earning investment). Examples are insurance, spoilage, interest on invested capital, obsolescence, and warehousing costs.
