Cost Management System Costs Associated with Goods for Sale 1. Purchasing costs include transportation costs. 2. Ordering costs include receiving and inspecting the items in the orders. 3. Carrying costs include the opportunity cost of the investment tied up in inventory and the costs associated with storage.

Cost Management System 4. Stockout costs occur when an organization runs out of a particular item for which there is a customer demand. 5. Quality costs of a product or service is its lack of conformance with a prespecified standard.

Cost Management System Economic-Order-Quantity Decision Model Assumptions 1. The same quantity is ordered at each reorder point. 2. Demand, ordering costs, carrying costs, and purchase-order lead time are known with certainty.

Cost Management System 4. No stockouts occur. 5. Quality costs are considered only to the extent that these costs affect ordering costs or carrying costs. 3. Purchasing costs per unit are unaffected by the quantity ordered.

Cost Management System EOQ = D = Demand in units for a specified time period P = Relevant ordering costs per purchase order C = Relevant carrying costs of one unit in stock for the time period used for D

Cost Management System Annual demand is 12,844 packages, at the rate of 247 packages per week. Video requires a 15% annual return on investment. The purchase-order lead time is two weeks. What is the economic-order-quantity?

Cost Management System Relevant ordering cost per purchase order: $209 Relevant carrying costs per package per year: Required annual ROI (15% × $15)$2.25 Relevant other costs 3.25 Total$5.50

Cost Management System = 988 packages EOQ =

Cost Management System What are the relevant total costs (RTC)? RTC = Annual relevant ordering costs + Annual relevant carrying costs RTC = Q can be any order quantity, not just the EOQ. DQDQ ×P+ Q2Q2 C× DP Q + QC 2 or

Cost Management System When Q = 988 units, RTC = (12,844 × $209 ÷ 988) + (988 × $5.50 ÷ 2) = $5,434 total relevant costs How many deliveries should occur each time period? D EOQ 12, ==13 deliveries

Cost Management System ,000 4,000 6,000 8,000 10,000 5, ,2001,800 2, EOQ Annual relevant carrying costs Annual relevant total costs Annual relevant ordering costs Order Quantity (Units)

Cost Management System Reorder Point Reorder point = Number of units sold per unit of time × Purchase-order lead time EOQ = 988 packages Number of units sold/week = 247 Purchase-order lead time = 2 weeks Reorder point = 247 × 2 = 494 packages

Cost Management System Weeks Reorder Point This exhibit assumes that demand and purchase-order lead time are certain: Demand = 247 tape packages/week Purchase-order lead time = 2 weeks Lead Time 2 weeks Lead Time 2 weeks

Cost Management System Safety Stock Safety stock is inventory held at all times regardless of the quantity of inventory ordered using the EOQ model. Video’s expected demand is 247 packages per week. Management feels that a maximum demand of 350 packages per week may occur.

Cost Management System How much safety stock should be carried? 350 Maximum demand – 247 Expected demand = 103 Excess demand per week 103 packages × 2 weeks lead time = 206 packages of safety stock.

Cost Management System Average inventory level of xxx 200 Orders per year 40 Average daily demand 48 Working days per year 250 Annual ordering costs 4,000 Annual carrying costs 6,000 Ralph purchases at the EOQ quantity level Determine: 1. Annual demand 2. Cost of placing an order 3. Annual carrying costs of one unit 4. The EOQ