Inventory Management Quiz

Inventory carrying costs are incurred to hold inventory. Examples includethe costs of storage, insurance, security, inventory taxes, depreciation orrent of warehouse facilities, obsolescence and spoilage, and the opportunitycost of inventory investment.

Inspection costs are not related to the lengthof time inventory is held. They are costs of taking delivery and are bestclassified as ordering costs.

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 6month period will be $900,000 [(180,000 × $10) ÷ 2].

If the specialpurchase is not made, the average inventory for the same period will be theaverage monthly inventory of $180,000 [(30,000 × $12) ÷ 2].

Accordingly,the incremental average inventory is $720,000 ($900,000 – $180,000),

andthe interest cost of the incremental 6 month investment is $32,400[($720,000 × 9%) ÷ 2].

If safety stock is 50 units, the receipt of an order should increase theinventory to 250. That amount will decline to 50 just prior to the receipt ofthe next order.

Thus, the average inventory would be the average of 250and 50 [(250 + 50) ÷ 2], or 150 units

This statement is least likely to explain an increase in current assets fromlast July to this July.

If the corporation was a seasonal company withtraditionally higher activity in the summer months, it would budget similaramounts for each summer in expectation of the high activity.

The suddenincrease in current assets for the following summer would not be explainedby the fact that they are a seasonal company.

Quantity discounts are not a factor in the EOQ formula.

Carrying costs are incurred to hold inventory. Examples include such costsas warehousing, insurance, the cost of capital invested in inventories,inventory taxes, and the cost of obsolescence and spoilage.

Shipping costsand the initial cost of the inventory are the purchase costs.

Relaxing the credit policy for customers will lead to increased salesbecause more people will be eligible for more credit.

As sales increase,purchase orders will increase to accommodate the higher sales levels.

The reorder point is the inventory level at which an order should be placed.

It can be quantified using the following equation:

Reorder point = (Average weekly demand × Lead time) + Safety stock

                             = [(12,000 units ÷ 50 weeks) × 5 weeks] + 1,500 units

                              = 1,200 units + 1,500 units

                               = 2,700 units

Carrying costs include storage costs, handling costs, insurance costs,interest on capital invested, and obsolescence.

The EOQ model is a deterministic model that calculates the ideal order (orproduction lot) quantity given specified demand, ordering or setup costs,and carrying costs.

The model minimizes the sum of inventory carryingcosts and either ordering or production setup costs.

A manufacturer can use the EOQ model by substituting production set-upcosts for ordering costs. Set-up costs are the manufacturer’s equivalent ofordering costs. The result is sometimes referred to as the economic batchquantity.

Fixed cost per order is in the numerator of the EOQ fraction. An increaseresults in an increase in the EOQ.

One of the underlying assumptions of the EOQ model is that delivery timesare predictably consistent.

Other assumptions are that sales are perfectlypredictable and that usage is constant.

Safety stock cannot protect against the entry of new competitors.

A company maintains safety stocks to protect itself against the lossescaused by stockouts.

These can take the form of lost sales or lostproduction time.

Safety stock is necessary because of the variability in leadtime and usage rates.

As the variability in lead time increases, a companywill tend to carry larger safety stocks.

The lead times does not affect the EOQ; it just means the order should beplaced four days earlier.

A firm’s economic order quantity is a function of demand, carrying costs,and ordering costs. A decrease in carrying costs permits a company to carrymore inventory at the same cost and thereby reduce stockout costs.

The cost of shipping inventory is a cost of acquiring, not carrying, it.