Inventory Management Paper 6

Answer (D) is correct. Inventory carrying costs are incurred to hold inventory. Examples include the costs of storage, insurance, security, inventory taxes, depreciation or rent of warehouse facilities, obsolescence and spoilage, and the opportunity cost of inventory investment. Inspection costs are not related to the length of time inventory is held. They are costs of taking delivery and are best classified as ordering costs.

Answer (B) is correct. The reorder point is the inventory level at which an order should be placed. It can be quantified using the following equation: Reorder point = (Average weekly demand × Lead time) + Safety stock = [(10,000 units ÷ 50 weeks) × 4 weeks] + 1,300 units = 800 units + 1,300 units = 2,100 units

Answer (B) is correct. The reorder point is the inventory level at which an order should be placed. It can be quantified using the following equation: Reorder point = (Average weekly demand × Lead time) + Safety stock = [(12,000 units ÷ 50 weeks) × 5 weeks] + 1,500 units = 1,200 units + 1,500 units = 2,700 units

Answer (C) is correct. A company maintains safety stocks to protect itself against the losses caused by stockouts. These can take the form of lost sales or lost production time. Safety stock is necessary because of the variability in lead time and usage rates. As the variability in lead time increases, a company will tend to carry larger safety stocks.

Answer (D) is correct. Determining the appropriate level of safety stock involves a complex probabilistic calculation that balances (1) the variability of demand for the good, (2) the variability in lead time, and (3) the level of risk the firm is willing to accept of having to incur stockout costs. Thus, the only one of the items listed that does not affect the level of safety stock is reorder costs.

Answer (A) is correct. Relaxing the credit policy for customers will lead to increased sales because more people will be eligible for more credit. As sales increase, purchase orders will increase to accommodate the higher sales levels.

Answer (B) is correct. 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 carry more inventory at the same cost and thereby reduce stockout costs.

Answer (D) is correct. The EOQ model is a deterministic model that calculates the ideal order (or production lot) quantity given specified demand, ordering or setup costs, and carrying costs. The model minimizes the sum of inventory carrying costs and either ordering or production setup costs.

Answer (B) is correct. If safety stock is 50 units, the receipt of an order should increase the inventory to 250. That amount will decline to 50 just prior to the receipt of the next order. Thus, the average inventory would be the average of 250 and 50 [(250 + 50) ÷ 2], or 150 units.

Answer (B) is correct. The lead times does not affect the EOQ; it just means the order should be placed four days earlier.