# Cornerstones of Cost Management Study Set 4

## Quiz 20 :Inventory Management: Economic Order Quantity, Jit, and the Theory of Constraints

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Constrained Optimization: Multiple Internal Constraints Fisher Company produces two types of components for airplanes: A and B, with unit contribution margins of $400 and$600, respectively. The components pass through three sequential processes: cutting, welding, and assembly. Data pertaining to these processes and market demand are given below (weekly data). Required: 1. Express Fisher Company's constrained optimization problem as a linear programming model. 2. Using a graphical approach, solve the linear programming model expressed in Requirement 1. Which constraints are binding? 3. What if Fisher Company had 10 additional machine hours (cutting) with all other resources held constant? What is the new optimal mix and associated total contribution margin? What is the incremental benefit per machine hour caused by the additional five hours, if any?
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What is the economic order quantity?
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EOQ (Economic Order Quantity) - EOQ indicates that the quantity is fixed in such a way that the total variable cost of managing the inventory can be minimized. It is the number of units in the optimal size order quantity. The formula is given below:
Where,
EOQ- optimal number of units to be ordered at one time
CO - cost of placing one order
D - Annual demand for the item in units
CC -cost of carrying one unit in inventory for a year

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Reorder Point Shorts Company manufactures backpacks. A heavy-duty strap is one part that the company orders from an outside supplier. Information pertaining to the strap is as follows: Required: 1. What is the reorder point assuming no safety stock is carried? 2. What is the reorder point assuming that safety stock is carried?
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Reorder point is the point at which new order of inventory should be placed to avoid stock-out.
Reorder point is calculated as follows:
Safety Stock is calculated as follows:
The following information of S ltd. is given:
(1)Calculation of Reorder Point assuming no safety stock is carried is as follows:
Hence, an order should be placed when inventory level drops to 1,260 units
(2)Calculation of Safety Stock is as follows:
Calculation of Reorder Point assuming that safety stock is carried is as follows:
Hence, an order should be placed when inventory level drops to 1,500 units

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Thomas Corporation produces heating units. The following values apply for a part used in their production (purchased from external suppliers): D = 12,500 Q = 250 P = $45 C =$4.50 Required: 1. For Thomas, calculate the ordering cost, the carrying cost, and the total cost associated with an order size of 250 units. 2. Calculate the EOQ and its associated ordering cost, carrying cost, and total cost. Compare and comment on the EOQ relative to the current order quantity. 3. What if Thomas enters into an exclusive supplier agreement with one supplier who will supply all of the demands with smaller, more frequent orders? Under this arrangement, the ordering cost is reduced to $0.45 per order. Calculate the new EOQ and comment on the implications. Essay Answer: Tags Choose question tag Reorder Point Sterling Corporation has an EOQ of 5,000 units. The company uses an average of 500 units per day. An order to replenish the part requires a lead time of five days. Required: 1. Calculate the reorder point, using Equation 20.3. 2. Graphically display the reorder point, where the vertical axis is inventory (units) and the horizontal axis is time (days). Show two replenishments, beginning at time zero with the economic order quantity in inventory. 3. What if the average usage per day of the part is 500 units but a daily maximum usage of 575 units is possible? What is the reorder point when this demand uncertainty exists? Essay Answer: Tags Choose question tag What are stock-out costs? Essay Answer: Tags Choose question tag Drum-Buffer-Rope See Cornerstone Exercise 20.4. Fisher Company has three sequential processes: cutting, welding, and assembly. Assume that the optimal mix is Component A ¼ 0 units per week; and Component B ¼ 30 units per week. Demand is uniformly spread out over the five-day work week. Fisher requires a 2.5-day buffer. Required: 1. Identify the drummer, the rate of production, the time buffer, and the rope. 2. Illustrate the DBR structure of Fisher Company. 3. What if the Welding Department was allowed or encouraged to produce at capacity? What effect will this have on work-in-process inventories? Essay Answer: Tags Choose question tag Explain how long-term contractual relationships with suppliers can reduce the acquisition cost of materials. Essay Answer: Tags Choose question tag One reason for inventory is to prevent shutdowns. How does the JIT approach to inventory management deal with this potential problem? Essay Answer: Tags Choose question tag Explain how the Kanban system helps reduce inventories. Essay Answer: Tags Choose question tag Constrained Optimization: One Internal Binding Constraint Patz Company produces two types of machine parts: Part A and Part B, with unit contribution margins of$300 and $600, respectively. Assume initially that Patz can sell all that is produced of either component. Part A requires two hours of assembly, and B requires five hours of assembly. The firm has 300 assembly hours per week. Required: 1. Express the objective of maximizing the total contribution margin subject to the assemblyhour constraint. 2. Identify the optimal amount that should be produced of each machine part and the total contribution margin associated with this mix. 3. What if market conditions are such that Patz can sell at most 75 units of Part A and 60 units of Part B? Express the objective function with its associated constraints for this case and identify the optimal mix and its associated total contribution margin. Essay Answer: Tags Choose question tag Economic Order Quantity Refer to the data in Exercise 20.6. Required: 1. Compute the economic order quantity. 2. Compute the ordering, carrying, and total costs for the EOQ. 3. How much money does using the EOQ policy save the company over the policy of purchasing 4,000 plastic housing units per order? Essay Answer: Tags Choose question tag Explain how safety stock is used to deal with demand uncertainty. Not Answered There is no answer for this question Tags Choose question tag Economic Order Quantity Melchar Company uses 78,125 pounds of oats each year. The cost of placing an order is$18, and the carrying cost for one pound of oats is $0.45. Required: 1. Compute the economic order quantity for oats. 2. Compute the carrying and ordering costs for the EOQ. Essay Answer: Tags Choose question tag Discuss the traditional reasons for carrying inventory. Essay Answer: Tags Choose question tag Ordering and Carrying Costs Ottis, Inc., uses 640,000 plastic housing units each year in its production of paper shredders. The cost of placing an order is$30. The cost of holding one unit of inventory for one year is $15.00. Currently, Ottis places 160 orders of 4,000 plastic housing units per year. Required: 1. Compute the annual ordering cost. 2. Compute the annual carrying cost. 3. Compute the cost of Ottis's current inventory policy. Is this the minimum cost? Why or why not? Essay Answer: Tags Choose question tag What are ordering costs? What are setup costs? What are carrying costs? Provide examples of each type of cost. Essay Answer: Tags Choose question tag EOQ with Setup Costs Morrison Manufacturing produces casings for sewing machines: large and small. To produce the different casings, equipment must be set up. The setup cost per production run is$18,000 for either casing. The cost of carrying small casings in inventory is $6 per casing per year; the cost of large casings is$18 per unit per year. To satisfy demand, the company produces 2,400,000 small casings and 800,000 large casings. Required: 1. Compute the number of small casings that should be produced per setup to minimize total setup and carrying costs. 2. Compute the setup, carrying, and total costs associated with the economic order quantity for the small casings.
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