Fin-301 (Inventory Management, Mathematics Problems)

Previous Year Questions

1. A college bookstore is attempting to determine the optimal order quantity for a popular book
on psychology. The store sells 5,000 copies of this book a year at a retail price of $12.50, and
the cost to the store is 20 percent less, which represents the discount from the publisher. The
store figures that it costs $1 per year to carry a book in inventory and $100 to prepare an order
for new books.
a)Determine the total inventory costs associated with ordering 1, 2, 5, 10, and 20 times a
year.
b) Determine the economic order quantity.
c) What implicit assumptions are being made about the annual sales rate?[2022-3.(c)]
(Van Horne's Book; Chapter-10, Problems-7)
2. A company, for one of its class 'A' items, placed 8 orders each for a lot of 150 numbers, in a
year. Given that the ordering cost is Tk. 5,400.00, the inventory holding cost is 40 percent, and
the cost per unit is Tk. 40.00. The company is making a loss for not using the EOQ Model under
order quantity policies.
(i) What are your recommendations for ordering the item in the future?
(ii) What should be the reorder level, if the lead time to deliver the item is 6 months?
(iii) Graphically determine the order quantity that minimizes total annual inventory costs
by plotting inventory costs as a function of the order quantity. [2021-2.(c)]
Answers:
(i) Given data,
The company is currently placing 8 orders of 150 units each,
So,Total annual demand(T)=8*150=1200 units
Ordering Costs per order (O)=Tk.5400
Carrying Costs per unit (C*PP)=(.40*40)=16
2*𝑇*𝑂
EOQ= 𝐶*𝑃𝑃

2*1200*5400
= 16
=900 units.
The recommended order quantity is 900 units. The company should adopt this Economic Order
Quantity (EOQ) to minimize its total inventory costs.

(ii) Given, annual demand(T)=1200 units, lead time =6 months.

The monthly demand =1200/12=100 units.
Reorder level=Maximum Usage(S or T)*lead time
=100*6 =600 units.
Therefore, the reorder level should be 600 units.

3. Perform the following calculations using a discount rate of 8 percent per year and an
income tax rate of 30 percent:
(i) Net profit for a reversible investment of $50000 which provides $18000 in additional
annual cash revenues and $6000 in additional annual cash costs.
(ii) Total cost for a reversible investment of $35000 with annual cash costs of $10500. This
is one of the several alternative investments that provide the same level of annual revenues.
(iii) Calculate the net present value for the investment in (1) assuming that funds are
withdrawn in five years.
(iv) Calculate the present value of costs for the investment in (ii) assuming that funds are
withdrawn in seven years.[2019-1. (c)]
Answers:
(i) Net profit is calculated as:
Net Profit=(Revenues - Costs)×(1−t)
Where:
Revenues = $18,000
Costs = $6,000
Tax rate (t) = 30%
Net Profit=(18,000−6,000)×(1−0.30)
=12,000×0.70=$8,400
(ii) Total Cost
The total cost of the investment is calculated as the present value of the annual cash costs.
Total Cost=Annual Costs×PV Factor
The PV Factor for a perpetuity discounted at 8% is:
1 1
PV Factor= 𝑟 = 0.08 =12.5

Annual cash costs = $10,500.

Total Cost=$10,500×12.5 =$131,250
(iii) Net Present Value (NPV)
The NPV is calculated as:
NPV=PV of Cash Flows−Initial Investment
First, calculate after-tax cash inflows:
After-tax Cash Flow=(Revenues−Costs)×(1−t)
=$8,400
The PV of cash flows for 5 years is:
5 𝑛
1−(1+𝑟)
PV Interest Factor (5 years)= ∑ = 𝑟
𝑛=1

Using a discount rate of 8%:

𝑛 5
1−(1+𝑟) 1−(1.08)
PV Interest Factor= 𝑟
= .08
=3.993

PV of Cash Flows=8,400×3.993=$33,545.2
NPV = PV of Cash Flows - Initial Investment
NPV=$33,545.2-$50,000 =−$16,454.8
(iv) Present Value of Costs
The PV of costs for 7 years is:
𝑛
1−(1+𝑟)
PV Factor (7 years)= 𝑟
7
1−(1.08)
= .08
=5.206

PV of Costs=Annual Costs×PV Factor

PV of Costs=$10,500×5.206=$54,663

4. An electronics store sells on average 30 volt-ohm meters (VOMs) per month. VOMs
are currently ordered in lots of 45 at a time, and the purchase price per VOM is $28.00. It
costs $7.50 to place an order, and annual holding costs are to be 6 percent of the
average inventory investment. The discount rate for inventory investment is 10 percent
and the tax rate is 30 percent per year.
(i) What is the total annual cost of this inventory policy including acquisition costs?
(ii) If any number of VOMs can be ordered at a time, what is the least cost number to
order? What would be the store's average investment in VOMs assuming no safety stock is
maintained?​[2018-2.(c)]
Answers:
(i) Total Annual Cost Excluding Acquisition Costs
Components:
Ordering Cost (OC):
Annual demand (D): 30 units/month × 12 months = 360 units/year
Lot size (Q): 45 units
Ordering cost per order (S): $7.50
OC=DQ×S=(360/45)×7.50=8×7.50=$60
Holding Cost (HC):
Holding cost rate (H): 6% of the purchase price
Purchase price per VOM (PP): $28
Average inventory: (Q/2)=45/2=22.5 units
H=0.06×P=0.06×28=$1.68 per unit per year HC=H×(Q/2)=1.68×22.5=$37.8
Total Annual Cost:
Total Cost=OC+HC=$60+$37.8=$97.8
(ii) Optimal Order Quantity (Q*):
Using the Economic Order Quantity (EOQ) formula:

2*𝐷*𝑆
Q*= 𝐻

D=360 units/year
S=$7.50
H=$1.68 USD per unit per year

2*360*7.50 540
Q*= $1.68
= 1.68
= 3214. 29 ≈56.7 units

Optimal order quantity: 57 units (rounded).

Average Investment in VOMs:
Average Inventory=Q*/2=57/2=28.5 units
Average Investment=Average Inventory×P=28.5×28=$798
Summary:
Total annual cost (excluding acquisition costs): $97.8
Optimal order quantity (Q*): 57 units
Average inventory investment: $798

Van Horne's Book

Self-problems
3. Vostick Filter Company is a distributor of air filters to retail stores. It buys its filters from
several manufacturers. Filters are ordered in lot sizes of 1,000, and each order costs $40 to
place. Demand from retail stores is 20,000 filters per month, and the carrying cost is $0.10 a
filter per month.
a. What is the optimal order quantity with respect to so many lot sizes (that is, what
multiple of 1,000 units should be ordered)?
b. What would be the optimal order quantity if the carrying cost were cut in half to $0.05 a
filter per month?
c. What would be the optimal order quantity if ordering costs were reduced to $10 per
order?
4. To reduce production start-up costs, Bodden Truck Company may manufacture longer runs of
the same truck. Estimated savings from the increase in efficiency are $260,000 per year.
However, inventory turnover will decrease from eight times a year to six times a year. The cost of
goods sold is $48 million on an annual basis. If the required before-tax rate of return on

investment in inventories is 15 percent, should the company instigate the new production
plan?

Problems:
8. The Hedge Corporation manufactures only one product: planks. The single raw material used
in making planks is the dint. For each plank manufactured, 12 dints are required. Assume that
the company manufactures 150,000 planks per year, that demand for planks is perfectly steady
throughout the year, that it costs $200 each time dints are ordered, and that carrying costs are
$8 per dint per year.
a. Determine the economic order quantity of dints.
b. What are the total inventory costs for Hedge (total carrying costs plus total ordering
costs)?
c. How many times per year would inventory be ordered?
9. A firm that sells 5,000 blivets per month is trying to determine how many blivets to keep in
inventory. The financial manager has determined that it costs $200 to place an order. The cost
of holding inventory is 4 cents per month per average blivet in inventory. A five-day lead time is
required for delivery of goods ordered. (This lead time is known with certainty.)
a. Develop the algebraic expression for determining the total cost of holding and ordering
inventory.
b. Plot the total holding costs and the total ordering costs on a graph where the horizontal
axis represents the size of the order and the vertical axis represents costs.
c. Determine the EOQ from the graph.
10. Common Scents, Inc., makes various scents for use in the manufacture of food products.
Although the company does maintain a safety stock, it has a policy of maintaining “lean”
inventories, with the result that customers sometimes must be turned away. In an analysis of
the situation, the company has estimated the cost of being out of stock associated with various
levels of safety stock:

Safety Stock Level LEVEL OF SAFETY (in gallon) ANNUAL COST STOCK OF
STOCKOUTS

Present 5,000 $26000

1 7,500 14000

2 10,000 7000

3 12,500 3000

4 15000 1000

5 17000 0
Carrying costs are $0.65 per gallon per year. What is the best level of safety stock for the
company?

Pandey’s Book
Illustrative Solved Problems
29.1 A manufacturing company has an expected usage of 50,000 units of certain products
during the next year. The cost of processing an order is $20 and the carrying cost per unit is
$0.50 for one year. Lead time on an order is five days and the company will keep a reserve
supply of two days’ usage.

You are required to calculate

(a) the economic order quantity and
(b) the reorder point. (Assume a 250-day year).
29.2 A customer ordered 5,000 units at the rate of 1,000 units per order during last year.
The production cost is $12 per unit—$8 for materials and labor and $4 for overhead
cost. It costs $1,500 to set up for one run of 1,000 units and inventory carrying cost is
20% of the production cost. Since this customer may buy at least 5,000 units this year,

the company would like to avoid making five different production runs. Determine
the most economic production run.
Quiz Exercises
2. A company has a $6 per year carrying cost on each unit of inventory, an annual
usage of 120,000 units, and an ordering cost of $200 per order. Calculate the
economic order quantity. If a quantity discount of $0.25 per unit is offered to the
company when it purchases lots of 1,000 units, should the discount be accepted?
3. A manufacturing company has an expected usage of 500,000 units of certain
products during the next year. The cost of processing an order is $100 and the carrying
cost per unit is $2 for one year. Lead time on an order is five days and the company will
keep a reserve supply of three days’ usage. You are required to calculate
(a) the economic order quantity and
(b) the reorder point. (Assume a 360-day year).
4. A firm’s estimated demand for a material during the next year is 25,000 units.
Acquisition costs are $250 per order and carrying cost is $5 per unit. The safety stock is
set at 25 percent of the EOQ. The daily usage is 100 units and lead time is 10 days.

Determine
(a) the EOQ,
(b) the safety stock, and
(c) the reorder point. (Assume 250-day working in a year).
Corporate Finance (Marcus's Book)
Self-Tests
4. The builders’ merchants have experienced an increase in demand for engineering
bricks. It now expects to sell 1.25 million bricks a year. Unfortunately, interest rates have
risen and the annual carrying cost of the inventory has increased to $.09 per brick. Order
costs have remained steady at $90 per order.
a.Rework Table 20.1 for each of the eight order sizes shown in the table.
b.Has the optimal inventory level risen or fallen? Explain why.
Practice Problems
10. Genuine Gems orders a full month’s worth of precious stones at the beginning of
every month. Over the month, it sells off its stock, at which point it restocks inventory for
the following month. It sells 200 gems per month, and the monthly carrying cost is $1
per gem. The fixed order cost is $20 per order.

Should the firm adjust its inventory policy? If so, should it order smaller stocks more
frequently or larger stocks less frequently?
11. Patty’s Pancakes orders pancake mix once a week. The mix is used up by the end of
the week, at which point more is reordered. Each time Patty orders pancake mix, she
spends about a half hour of her time, which she estimates is worth $20. Patty sells 200
 pounds of pancakes each week. The carrying cost of each pound of the mix is 5 cents
per week.

(i) Should Patty restock more or less frequently?

(ii) What is the cost-minimizing order size?
(iii) How many times per month should Patty restock?
12. A large consulting firm orders photocopying paper by the carton. The firm pays a
$30 delivery charge on each order. The total cost of storing the paper, including forgone
interest, storage space, and deterioration, comes to about $1.50 per carton per month.
The firm uses about 1,000 cartons of paper per month.

a. Fill in the following table:

Order Size

100 200 250 500

Orders per month ________ ________ ________ ________

Total order cost ________ ________ ________ ________

Average inventory ________ ________ ________ ________

Total carrying costs ________ ________ ________ ________

Total inventory costs ________ ________ ________ ________

b. Calculate the economic order quantity. Is your answer consistent with your
findings in part (a)?
13 & 14. Micro-Encapsulator Corp. (MEC) expects to sell 7,200 miniature home
encapsulators this year. The cost of placing an order from its supplier is $250. Each unit
costs $50 and carrying costs are 20 percent of the purchase price.

a. What is the economic order quantity?

b. What are the total costs—order costs plus carrying costs—of inventory over the
year?
c(14). Suppose now that the supplier in the previous problem offers a 1 percent
discount on orders of 1,800 units or more. Should MEC accept the supplier’s offer?