CASE IN FINANCIAL

MANAGEMENT
CASE 18 INVENTORY
(ECONOMIC ORDER
QUANTITY)

BACKGROUND OF BOWEN
BUILT, INC.
Founder - Tim Bowen in 1978
Custom manufacturer for recreational vehicle (RV)
Produce 11 trailer models for sale in four states through dealers
Produce certain models for inventory
Peak period is during mid-spring to mid-fall (6 months)
Sales credit term 2/10, net 90
Last year sales $24 million
Just-in-time system for items costing more than $100
Two-bin system for items costing less than $20
Items costing between $20 to $100 has a total inventory of
$800,000 (example item is brake pumps)

INVENTORY
Brake pumps
- used at constant rate,
- Uses 12,000 units per year
- Operating time: 50 weeks
- Order cost per order, O: $60
- Carrying cost, c: 20%
- Safety stock: 2 weeks
- Interval time: 2 weeks

SUPPLIER
Precision
engineering

Kentech Manufacturing, Inc

Option 1

Option 2

Item cost

$30

$29

$28.5

Order Quantity/
Standard
shipping unit

100

1,000

2,000

Carrying Cost

$6

$5.8

$5.7

Ordering Cost

$60

$60

$60

Handling cost

$300 if more
than 100 units

FORMULA

Question
1

The total EOQ cost is,

ANSWERS

However, Bowen
currently ordering 500
units per order. Hence,
the total cost of the
current order is as
follows:

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ANSWERS
Question
2

Option
Option
1
1

Option 2

Option 2

ANSWERS
Question 3
Yes, Bowen should use Kentech because they offer
pump with lower price than Precision. The lower the
price, the lower the carrying cost. Also, there no
handling fee per order for Kentech. Bowen can save
$300 per order if he use Kentech.

ANSWERS
Question 4
Bowen should order 1,000 units with the price $29 per
unit. He can save up to $2440.
Option
Option
1 1

Option 2

Option 2

Q= 1,000
Q= 1,000

Q= 2,000

Q= 2,000

TC (28.5) TC (29) = $6060-$3620 =$2440

TC (28.5) TC (29) = $6060-$3620 =$2440
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ANSWERS
10

Question 5
EOQ Assumptions:
Constant or uniform demand
Constant unit price
Constant carrying costs
Constant ordering cost
Instantaneous delivery
Independent orders

These
assumptions
have been
pointed out to
illustrate the
limitations of the
basic EOQ
model and the
ways in which it
can be easily
modified to
compensate for
them.

The assumption is reasonable, because Bowen Built Inc use

"make-to-stock" strategy and the item has relatively stable
demand. Carrying costs and setup or ordering costs are
known and relatively stable.

ANSWERS
11

Question 6
Factors besides EOQ in determining a
supplier.
Terms of credit
Location of the supplier
Credit worthiness of the supplier
Warehousing facilities available with the
supplier
Size of the suppliers firm and their

ANSWERS
12

Reorder Point when safety stock is

generously 2 weeks:
RP = (2 * 240) + 2 * 240 = 960
Reorder point whe safety stock is
trimmed into 1 week:
RP = (2 * 240) + 1* 240 = 720

Question 7
Cost Reduction by Adjusting
Reorder Point:
Perry decided to study in detail
a single item, brake pumps, to
help him learn more about the
potential savings. Therefore,
the specific item that is
examined is the brake pumps.
Annual usage of Brake Pump:
12,000 units
Operation Time in a Year: 50
weeks

Number of orders in a year:

RP (Safety Stock 2 weeks) 12,000 / 960 =
12.5 times
RP (Safety Stock 1 week) 12,000 / 720 =
16.67 times
Units of safety stock annually:
RP (Safety Stock 2 weeks) 12.5 * 2* 280 =
6,000 units
RP (Safety Stock 1 week) 16.67 *1* 280 =
4,000 units

ANSWERS
13

Question 8
Carrying Cost:
Total cost of holding inventory over some
period of time
Short term
Warehousing costs rent, utilities and
salaries, financial costs such as
opportunity cost, and inventory costs
related to perishability, pilferage, shrinkage
and insurance.
Utilized to help determine how much profit
can be made on current inventory
Helps to find out if there is a need to
produce more or less
Carrying cost is expected to be a short term
because cost like rent, utilities, insurance,
breakage is paid not in a long term basis.

ANSWERS
14

Question 9
Change in Carrying Cost Affecting EOQ:
Surely a change in carrying cost will affect the EOQ
The more carrying cost needed, the lower rate of EOQ will be generated.
Suppose the carrying cost is now 30 percent, surely this would affect the
EOQ. The EOQ will be reduced by around 41% from the EOQ with the
carrying cost of 20 percent
Formula:

ANSWERS
15

However, even though a change in

carrying cost influence the overall EOQ,
the change will not affect the choice of
supplier in this case.
Because the preference of supplier does
not rely on the carrying cost but to the
Order Cost per order.
Carrying cost is a constant in determining
such preference in this case.

Carrying Cost is calculated as Carrying

Cost percentage x Cost per unit
So in this case, we can see the increment
in Carrying cost percentage will increase
the overall Carrying cost for both of the
supplier.

ANSWERS
16

We can compare the

calculation of the Carrying
Cost of 30 percent carrying
cost percentage with the
previous level of 20 percent
and it will generate the ratio
of 1:1.5 equally for all
options.

We can see that the

preference choice depends
on the Cost per unit instead
of the percentage of carrying
cost.

17

ANSWERS
Question 10
How a growing firm could be profitable but have cash flow
problem
Low profits or losses
Over-investment in capacity
Too much stock and poor inventory management
Allowing customers too much credit
Overtrading and growing too fast
Seasonal demand
Over investment in fixed assets

18

ANSWERS
Question 11
Should separate parts inventory into groups
according to value?
It is appropriate to group similar or related parts
for inventory relating to the same product and for
inventory that cannot be evaluated separately
from other parts in that product line because it is
not yet considered as finished goods

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SCENARIO ANALYSIS
1. If Precision Engineering dissolve the handling fee,
which supplier should Bowen choose?

Bowen should
choose Precision
Engineering.

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further review

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2. If Kentech also apply the special handling fee, which

supplier should Bowen choose?

Bowen should
choose Kentech
and order 1,000
units.

For Dr. Tareqs

further review