Computers 4 U is an online company that sells computers to individual consumers. The annual demand for one model that will be shipped from the northeast distribution centre is estimated to be 500,000 computers. The ordering cost is $800 per order. The cost of carrying a computer in inventory is $50 per year, which includes $20 in opportunity cost of investment. The average purchase cost of a computer is $200.
1. Compute the optimal order quantity using the EOQ model.
2. Compute the number of orders per year and the annual relevant total cost of ordering and holding inventory.
3. Assume that the benchmark that is used to evaluate distribution centre managers includes only the out-of-pocket costs incurred (that is, managers’ evaluations do not include the opportunity cost of investment tied up in holding inventory). If the manager makes the
EOQ decision based upon the benchmark, the order quantity would be calculated using a carrying cost of $30, not $50. How would this affect the EOQ amount and the actual annual relevant cost of ordering and carrying inventory?
4. What will the inconsistency between the actual carrying cost and the benchmark used to evaluate managers cost the company? Why do you think the company currently excludes the opportunity costs from the calculation of the benchmark? What could the company do to encourage the manager to make decisions more congruent with the goal of reducing total inventory costs?