Shields carries a part that is popular in the manufacture of automatic sprayers. Demand for this part is 4,000 units per year; order costs amount to $30 per order, and holding costs total $1.50 per unit.
The company, which currently places four orders per year with its suppliers, is considering the implementation of an economic order quantity (EOQ) model to better manage its inventories. Preliminary EOQ calculations revealed an optimal order quantity of 400 units and total annual inventory costs of $600.
Required:
A. In comparison with its current policy, how much will Shields save by adopting the EOQ model?
B. Briefly explain the philosophical difference between the EOQ model and the just-in-time model. Which of the two models will likely result in lower holding costs for the firm? Why?

Question

Quizplus · Accepted Answer

The Answer is A. Shields is currently ordering four times each year, resulting in order costs of $120 ($30 x 4). Each order is for 1,000 units (4,000 ÷ 4), which gives rise to an average inventory of 500 units (1,000 ÷ 2) and holding costs of $750 (500 x $1.50). Total costs under the current policy are $870 ($120 + $750), and the EOQ produces a $270 savings for the company ($870 - $600).
B. The EOQ model assumes that some inventory is necessary for business operations, and the goal is to optimize the order quantity to produce a situation where ordering costs equal holding costs. In contrast, under JIT, holding inventory in a warehouse is deemed to be inefficient and wasteful. Thus, inventory should be minimized and even eliminated, if possible.
Inventory under a JIT system is typically lower and, thus, holding costs are lower with this approach.

Shields Carries a Part That Is Popular in the Manufacture