AF313 TUTORIAL COLLECTION 4 – ECONOMIC ORDER QUANTITY

Bundaberg Glass Company is a distributor of car windscreens. The windscreens are

manufactured in Japan and shipped to Bundaberg. Management is expecting an annual
demand of 10 800 windscreens. The purchase price of each windscreen is $400. Other costs
associated with ordering and maintaining an inventory of these windscreens are shown
below.

 The ordering costs incurred in the purchase order department for placing and
processing orders for the past three years are shown below.

Year Orders placed and processed Total processing costs

1 17 $12300
2 55 12475
3 97 12700

 Management expects these ordering costs to increase by 16 per cent over the amounts
and rates experienced in the last three years.
 Each order is inspected by Australian custom officers. A fee of $47 is charged.
 A clerk in the receiving department receives, inspects and secures the windscreens as
they arrive from the manufacturer. The activity requires 4 hours per order received.
This clerk has no other responsibilities and is paid at the rate of $24 per hour. Related
variable overhead costs in this department are applied at the rate of $6 per hour.
 Additional warehouse space will have to be rented to store the new windscreens.
Space can be rented as needed in a warehouse at an estimated cost of $2500 per year
plus $6.25 per windscreen.
 Breakage cost is estimated to average $4 per windscreen.
 Insurance on the inventory costs $1.25 per windscreen.
 Other carrying costs amount to $8.50 per windscreen.

Bundaberg Glass Company works 6-day week for 50 weeks each year. The firm is closed
for two weeks each year. Six working days are required for the time the order is placed
with the supplier until it is received.

Required:

1. Assuming that all costs other than the order costs remain the same, calculate the
following amounts for the Bundaberg Glass Company for year 4:
a. The amount of the ordering cost that should be used in the EOQ formula
(Hint: Use the high-low method to estimate the incremental processing cost
per order.)
b. Amount of the carrying cost that should be used in the EOQ formula
c. Economic order quantity
d. Minimum annual relevant cost of ordering and carrying at the economic order
quantity
e. Reorder point in units.

2. Management has been able to negotiate a JIT purchasing agreement with the Japanese
manufacturer, and the inspection fee has been renegotiated with the custom officials.
The purchasing manager has determined that JIT purchasing would enable the
company to reduce the ordering cost to $32.50 per order. Moreover, she has analysed
the cost of storing windscreens, taking care to include the cost of wasted space and
inefficiency. She estimates that the real annual cost of carrying inventory is $60 per
windscreen.
a. Calculate the new EOQ, given the purchasing manager’s new cost estimates
b. How many orders would now be placed each year?
c. Calculate the new minimum annual relevant cost of ordering and carrying
inventory.