Question

Parker Hi-Fi Systems Parker Hi-Fi Systems, located in Wellesley, Massachusetts, a Boston suburb, assembles and sells the very finest home theater systems. The systems are assembled with components from the best manufacturers worldwide. Although most of the components are procured from wholesalers on the east coast, some critical items, such as LCD screens, come directly from their manufacturer. For instance, the LCD screens are shipped via air from Foxy, Ltd., in Taiwan, to Boston’s Logan airport, and the top-of-the-line speakers are purchased from the world-renowned U.S. manufacturer Boss. Parker’s purchasing agent, Raktim Pal, submits an order release for LCD screens once every 4 weeks. The company’s annual requirements total 500 units (2 per working day), and Parker’s per unit cost is $1,500. (Because of Parker’s relatively low volume and the quality focus—rather than volume focus—of many of Parker’s supplies, Parker is seldom able to obtain quantity discounts.) Since Foxy promises delivery within 1 week following receipt of an order release, Parker has never had a shortage of LCDs. (Total time between date of the release and date of receipt is 1 week or 5 working days.) Parker’s activity-based costing system has generated the following inventory-related costs. Procurement costs, which amount to $500 per order, include the actual labor costs involved in ordering, custom inspection, arranging for airport pickup, delivery to the plant, maintaining inventory records, and arranging for the bank to issue a check. Parker’s holding costs take into account storage, damage, insurance, taxes, and so forth on a square-foot basis. These costs equal $150 per LCD per year. With added emphasis being placed on efficiencies in the supply chain, Parker’s president has asked Raktim to seriously evaluate the purchase of the LCDs. One area to be closely scrutinized for possible cost savings is inventory procurement.

Discussion Questions

1. What is the optimal order number of LCDs that should be placed in each order?

2. What is the optimal reorder point (ROP) for LCDs?

3. What cost savings will Parker realize if it implements an order plan based on EOQ?

Answer 1

Following details are provided:

Annual demand of LCDs = D = 500 units

Order procurement cost = Co = $500

Annual unit inventory holding cost = Ch = $150

Therefore,

Optimal order number of LCDs that should be placed

= Square root ( 2 x 500 x 500/150 )

= 57.73 ( 58 rounded to nearest whole number )

OPTIMAL ORDER NUMBER OF LCDS = 58

Following details are provided :

Period of order review and release = P = 4 weeks

Lead time of delivery = L = 1 week

Therefore , Protection period = P + L = 4 + 1 = 5 weeks ( or , 5 x 5 = 25 working days )

Daily requirement of LCD = 2 units

Therefore , Reorder point = Daily requirement x Protection period = 2 x 25 = 50 LCDs

OPTIMAL REORDER POINT FOR LCDs = 50

The cost savings if EOQ is will be on total annual ordering cost plus total annual inventory holding cost.

At EOQ, sum of total ordering cost and total inventory holding cost is minimum