Refer to Fig. 8. Suppose that (i) the ordering cost for each...

Refer to Fig. 8. Suppose that (i) the ordering cost for each delivery of dried cherries is $$\$ 50$$, and (ii) it costs $$\$ 7$$ to carry 1 pound of dried cherries in inventory for 1 year. (a) What is the inventory cost (carrying cost plus ordering cost) if carrying costs are computed on the average inventory during the order-reorder period? (b) What is the inventory cost if carrying costs are computed on the maximum inventory during the orderreorder period?

Refer to Fig. 8. Suppose that
(i) the ordering cost for each delivery of dried cherries is $$\$ 50$$, and
(ii) it costs $$\$ 7$$ to carry 1 pound of dried cherries in inventory for 1 year.
(a) What is the inventory cost (carrying cost plus ordering cost) if carrying costs are computed on the average inventory during the order-reorder period?
(b) What is the inventory cost if carrying costs are computed on the maximum inventory during the orderreorder period?

Key Concepts

Ordering Cost

Ordering cost refers to the fixed expense incurred each time an order is placed, regardless of the order quantity. This cost typically includes administrative expenses, transportation, and other costs associated with processing and receiving an order. In inventory management, reducing the number of orders by increasing the order size can lower total ordering costs, but it may lead to higher inventory levels and subsequently higher carrying costs.

Economic Order Quantity (EOQ) Model

The EOQ model is a fundamental concept in inventory management that aims to determine the ideal order quantity which minimizes the sum of ordering, holding, and shortage costs. It balances the trade-off between ordering too frequently, which raises ordering costs, and ordering too much, which increases carrying or holding costs. The model assumes a constant demand rate and instantaneous replenishment, providing a simplified approach to achieve cost efficiency in inventory management.

Carrying Cost

Carrying cost, also known as holding cost, comprises the expenses associated with storing and maintaining inventory over time. This includes costs such as storage, insurance, depreciation, and the opportunity cost of capital. Carrying costs are often calculated on an annual basis either based on the average inventory level, which assumes that inventory declines linearly over time, or on the maximum inventory level, which typically yields a higher estimate.

Average vs Maximum Inventory Levels

In inventory cost analysis, the average inventory level is commonly used as it represents the typical amount of inventory held over a specific period, usually estimated as half of the order quantity under a linear consumption assumption. However, when costs are computed on the maximum inventory level, the calculation is based on the peak inventory immediately after replenishment. This distinction is crucial because using the maximum level can result in higher carrying cost estimates compared to using the average inventory.

Please give Ace some feedback