Deck 20: Inventory Management

Question 1

Shields carries a part that is popular in the manufacture of automatic sprayers. Demand for this part is 4,000 units per year; order costs amount to $30 per order, and holding costs total $1.50 per unit.
The company, which currently places four orders per year with its suppliers, is considering the implementation of an economic order quantity (EOQ) model to better manage its inventories. Preliminary EOQ calculations revealed an optimal order quantity of 400 units and total annual inventory costs of $600.
Required:
A. In comparison with its current policy, how much will Shields save by adopting the EOQ model?
B. Briefly explain the philosophical difference between the EOQ model and the just-in-time model. Which of the two models will likely result in lower holding costs for the firm? Why?

Answer 1

A. Shields is currently ordering four times each year, resulting in order costs of $120 ($30 x 4). Each order is for 1,000 units (4,000 ÷ 4), which gives rise to an average inventory of 500 units (1,000 ÷ 2) and holding costs of $750 (500 x $1.50). Total costs under the current policy are $870 ($120 + $750), and the EOQ produces a $270 savings for the company ($870 - $600).
B. The EOQ model assumes that some inventory is necessary for business operations, and the goal is to optimize the order quantity to produce a situation where ordering costs equal holding costs. In contrast, under JIT, holding inventory in a warehouse is deemed to be inefficient and wasteful. Thus, inventory should be minimized and even eliminated, if possible.
Inventory under a JIT system is typically lower and, thus, holding costs are lower with this approach.

Question 2

Cartwright Graphics uses a special purpose paper on 80% of its jobs. The paper is purchased in 100-sheet packages at a cost of $100 per package. Management estimates that the cost of placing and receiving a typical order is $15, and the annual cost of carrying a package in inventory is $1.50. Cartwright uses 2,600 packages each year. Production is constant, and the lead time to receive an order is 1 week.
The economic order quantity is approximately:

A) 203 packages.
B) 225 packages.
C) 228 packages.
D) 565 packages.
E) 631 packages.

Answer 2

C

Question 3

Which of the following is classified as an inventory shortage cost?

A) Purchase order preparation.
B) Production disruption.
C) Lost sales and lost customers.
D) Spoilage.
E) Both production disruption and lost sales and lost customers.

Answer 3

E

Question 4

When comparing EOQ and JIT inventory systems, which of the following statements is false?

A) The EOQ approach takes the viewpoint that some inventory is necessary.
B) The EOQ system assumes a constant order quantity.
C) JIT argues that inventory investments should be minimized.
D) The EOQ system focuses on acquisition and holding costs.
E) JIT argues that safety stocks are necessary to reduce the probability of a stock shortage.

Question 5

Cartwright Graphics uses a special purpose paper on 80% of its jobs. The paper is purchased in 100-sheet packages at a cost of $100 per package. Management estimates that the cost of placing and receiving a typical order is $15, and the annual cost of carrying a package in inventory is $1.50. Cartwright uses 2,600 packages each year. Production is constant, and the lead time to receive an order is 1 week.
The reorder point is:

A) 25 packages.
B) 50 packages.
C) 100 packages.
D) 203 packages.
E) 225 packages.

Question 6

Economic Order Quantity, timing of orders and safety stock are three important considerations in inventory management.
Required:
A. Explain each of these considerations.
B. How is EOQ affected by the timing of orders and safety stock?

Question 7

Inventory holding costs would typically include all of the following except:

A) insurance.
B) theft.
C) transportation.
D) obsolescence.
E) warehouse rent.

Question 8

Which of the following does not minimize ordering costs when using JIT purchasing?

A) Reducing the number of vendors.
B) Negotiating long-term supply agreements.
C) Making less frequent payments.
D) Maintaining a safety stock.
E) Eliminating inspections.

Question 9

Burgoon uses an economic order quantity model and has determined an optimal order size of 500 units. Annual demand is 10,000 units, ordering costs are $50 per order, and holding costs are $4 per unit. The company's annual ordering and holding costs total:

A) $2,000.
B) $3,000.
C) $21,000.
D) $41,000.
E) none of the other answers are correct.

Question 10

When considering safety stock and its effect on EOQ, which of the following statements is false?

A) Safety stock is equal to the potential excess usage of an input.
B) The reorder point is affected by the existence of safety stock.
C) Safety stock decreases inventory holding costs.
D) Safety stock decreases the potential costs caused by inventory shortages.
E) Fluctuations in monthly usage of a material indicate the desirability of a safety stock.

Question 11

At the economic order quantity:

A) total annual inventory costs, holding costs, and ordering costs are all minimized.
B) total annual inventory costs and holding costs are minimized.
C) total annual inventory costs are minimized, and holding costs equal ordering costs.
D) total annual inventory costs are minimized, and holding costs exceed ordering costs.
E) total annual inventory costs are minimized, and ordering costs exceed holding costs.

Question 12

When graphing the EOQ, which of the following statements is false?

A) Holding costs are a downward sloping line to the right.
B) The EOQ is represented by the minimum total cost.
C) Ordering costs are a downward sloping line to the right.
D) Average inventory on hand results in higher holding costs.
E) As order size increases, so does average inventory on hand.

Question 13

Inventory holding costs typically include:

A) clerical costs of purchase-order preparation.
B) costs of deterioration, theft, or spoilage.
C) costs associated with lost sales to customers.
D) forgone interest on money tied up in inventory.
E) both costs of deterioration, theft, or spoilage and forgone interest on money tied up in inventory.

Question 14

Shields carries a part that is popular in the manufacture of automatic sprayers. Demand for this part is 4,000 units per year; order costs amount to $30 per order, and holding costs total $1.50 per unit. The company is considering the implementation of an economic order quantity model in an effort to better manage its inventories.
Required:
A. Compute the economic order quantity.
B. Compute total annual inventory costs if Shields follows the EOQ policy.