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Saturday, 24 May 2014 07:51

CASE 9-1: LOW NAIL COMPANY Featured

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CASE 9-1: LOW NAIL COMPANY


The economic order quantity (EOQ) is an inventory control approach for balancing ordering costs and ordering costs with the goal of minimizing inventory costs. Ordering costs are clerical, administrative and other expenses that occur when obtaining inventory items and keeping them for storage. Keeping the bought item also involves holding, carrying and other costs and experiences resulting from breakage, pilferage, insurance and storage. In order to determine the EOQ, a given calculus is the mathematical model is used.


 Thesis statement

The EOQ method uses an equation that includes the following items, ordering costs (O), annual demand (D), holding costs (H). The basic equation is represented in the equation below:


 Purpose of the paper

This paper will answer three questions in analyzing the various calculations that low has to understand his inventory costs based on the EOQ method. The first will be the number of kegs of nails that Low has to order. I will calculate this by using the EOQ approach outlined in chapter 8 of Murphy and Wood (2010) book. The second question will consider a case were 750 orders of kegs nails are made, and the supplier will take care of all the costs for order processing. However if the orders will be between 249 and 749 kegs the supplier will only cater for half the costs. Then how much will the new EOQ for low be? The last question will be on Low’s new EOQ if the wholesale costs of nails will be $ for every keg and him having to pay an interest of 1.5 % per month for unsold inventory.


 3. Body

A.) EOQ methods

EOQ model is based on the logic that; determining the quantity of an order calls for the need of a company to balance two types of costs. First is the cost of the inventory and the costs incurred for ordering the inventory. The cost of an inventory is in direct proportion to the size of the order. This means that the larger the order, then the high carrying cost of inventory and vice versa. On the contrary, ordering cost does decline with the size of the order in a nonlinear fashion. Therefore, EOQ is about finding the quantity point at which the costs of ordering is equivalent to carrying costs (Murphy and Wood2010).


 The EOQ formula is as follows:

EOQ= √ 2 (annual use in units) (cost of placing an order) / annual carrying cost per item per year = √ 2 (2000) (60) / 2

= √ 120,000

= 345 kegs per order

From the above calculations, 2 acts as the dominator because, on average the rented space of a warehouse is always half full resulting to warehousing costs for every keg to be $2 on average.


 B. New EOQ for Low

Orders/year

Order size

Processing costs ($)

Warehousing costs ($)

Sum of processing and warehousing costs ($)

1

2,000

Free

2,000

2,000

2

1,000

Free

1,000

1,000

3

667

90

667

757

4

500

120

500

620

5

400

150

400

550

6

334

180

334

514

7

286

210

286

496

8

250

240

250

490

9

223

540

223

743

The new EOQ for Low is 250Kegs as shown in the above tabular information. C. with the assumption that the wholesale costs of nails will be at $40 per keg and that Low will have to pay an interest of 1.5% every month for unsold inventory his new EOQ will be calculated in the tabular format below: the inventory interests will be examined in a new column. The assumption will be that if a single order is placed for a year the average inventory will be 1, 000 kegs being worth $40,000. The annual interest charges will be 12×1.5= 18%, which is $7, 200. Other costs of interests will be calculated in the same fashion with the average inventory rate adjustments. The table below shows these calculations:


 

Orders/year

Order size

Processing costs ($)

Warehousing costs ($)

Interest costs ($)

Sum of processing, warehousing, and interest costs ($)

1

2,000

60

2,000

7,200

9,260

2

1,000

120

1,000

3,600

4,720

3

667

180

667

2,405

3,252

4

500

240

500

1,800

2,540

5

400

300

400

1,440

2,140

6

334

360

334

1,203

1,897

7

286

420

286

1,030

1,736

8

250

480

250

900

1,630

9

223

540

223

807

1,570

10

200

600

200

720

1,520

11

182

660

182

656

1,498

12

167

720

167

605

1,492

13

154

780

154

555

1,489

14

143

840

143

519

1,50

 Therefore, the new EOQ will be 154kgs as shown in the above tabular information.


Conclusion

By using the EOQ method, it will be possible for Low and other business managers to decide the amount that they should order. Managers also have to determine the RIP which is the reorder point. RIP is the level of inventory that a new order should be made. In determine the RIP, managers have to estimate the lead time which is the time between receiving an order and when it was placed (Mentzer, 2001).


 Reference

Mentzer, J (2001) Supply Chain Management. Sage publisher, p 214

Murphy, P and Wood D (2010) Contemporary logistics. Prentice Hall, p 152-153



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