Question

A manager at a manufacturing factory mus choose between two shipping alternatives: 2 day freight and 5 day freight. Using 5 day freight would cost $120 less than using 2 day freight. The primary consideration is the holding cost which is $12 per unit per year. 2000 items are to be shipped. Which alternative would you recommend ? EXPLAIN

Answer 1

The manager has two options : 2 day freight and 5 day freight.

Given is that 5 day freight would cost $120 less than the other option of 2 day freight. But using 5 day freight means holding costs for 5 days instead of 2 days in 2 day freight. Which means holding cost of 3 days must be considered as well.

Incremental holding cost for 3 days = holding cost*number of units *number of days /365 =12*2000*3/365= $197.26

Amount of $197.26 will have to be paid in extra as holding cost if the manager chooses the 5 day freight option.

If we consider our savings and extra costs with 5 day freight, we can understand that manager should choose 2 day freight since the 5 day freight would cost manager more.

Because extra cost or incremental cost ($197.26)>savings ($120).

Choose option of 2 day freight.