Inventory Management Quiz

Determining the appropriate level of safety stock involves a complexprobabilistic calculation that balances

1. the variability of demand for thegood,
2. the variability in lead time, and
3. the level of risk the firm iswilling to accept of having to incur stockout costs.

Thus, the only one ofthe items listed that does not affect the level of safety stock is reorder costs.

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.

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.

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

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

The optimal level of inventory is affected by the factors in the economicorder quantity (EOQ) model and delivery or production lead times. Thesefactors are the annual demand for inventory, the carrying cost, whichincludes the interest on funds invested in inventory, the usage rate, and thecost of placing an order or making a production run. The current level ofinventory has nothing to do with the optimal inventory level.

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.

A just-in-time (JIT) inventory management system limits the output ofeach manufacturing operation to the demand of the next operation.

Shipment of raw materials from vendors are scheduled to arrive “just intime” to be used in the production process.

Inventory storage is considereda nonvalue adding activity, and raw materials on hand are thus kept to aminimum.

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].

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.

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.

Inventory costs consist of four categories: purchase costs, order or set-upcosts, carrying (holding) costs, and stockout costs.

Carrying costs includestorage costs for inventory items plus opportunity cost (i.e., the costincurred by investing in inventory rather than making an income-earninginvestment). Examples are insurance, spoilage, interest on invested capital,obsolescence, and warehousing 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 company’s per-gallon carrying cost is $2.40 ($12 purchase price pergallon × 20% carrying cost).

The cost of carrying safety stock is $5,760(2,400 gallons × $2.40),

and the cost of carrying average inventory is$2,400 (1,000 gallons × $2.40).

Thus, total inventory carrying cost is$8,160 ($5,760 + $2,400).

Safety stock cannot protect against the entry of new competitors.

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