1. CASE IN FINANCIAL
MANAGEMENT
CASE 18 – INVENTORY
(ECONOMIC ORDER
QUANTITY)
1

2. 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)
2

3. 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
3

4. 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
- -
4

5. FORMULA
𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 = 𝑐𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟𝑐𝑒𝑛𝑡𝑎𝑔𝑒 × 𝑐𝑜𝑠𝑡 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝑅𝑒𝑜𝑟𝑑𝑒𝑟 𝑝𝑜𝑖𝑛𝑡 = 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒 × 𝑤𝑒𝑒𝑘𝑙𝑦 𝑢𝑠𝑎𝑔𝑒 + 𝑠𝑎𝑓𝑒𝑡𝑦 𝑠𝑡𝑜𝑐𝑘
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 = 𝑂
𝑆
𝑄
+ 𝑐
𝑄
2
5

6. ANSWERSQuestion 1
• 𝑐 = 0.2 × 30 = 6
• 𝑂 = 300 + 60 = 360
EOQ =
2𝑆𝑂
𝑐
=
2×12,000×360
0.2×30
= 397.5 =
380 𝑢𝑛𝑖𝑡𝑠
The total EOQ cost is,
𝑇𝐶 30 =
360 × 12,000
380
+
6 × 380
2
= $12508.42
However, Bowen currently
ordering 500 units per
order. Hence, the total
cost of the current order is
as follows:
𝑇𝐶 30
=
360 × 12000
500
+
6 × 500
2
= $10140
6
For Dr. Tareq’s further
review

7. ANSWERS
Question
2
Option 1 Option 2
𝑐 = 0.2 × 29 = 5.8
𝐸𝑂𝑄 =
2 × 12,000 × 60
5.8
= 498.27 = 498 𝑢𝑛𝑖𝑡𝑠
𝑇𝐶 29
=
60 × 12,000
498
+
5.8 × 498
2
= $2890
𝑐 = 0.2 × 28.5 = 5.7
𝐸𝑂𝑄 =
2 × 12,000 × 60
5.7
= 502.62 = 503 𝑢𝑛𝑖𝑡𝑠
𝑇𝐶 28.5
=
60 × 12,000
503
+
5.7 × 503
2
= $2865
7

8. 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.
𝑁𝑜 𝑜𝑓 𝑜𝑟𝑑𝑒𝑟 =
𝑆
𝑄
=
12,000
500
=
24 𝑜𝑟𝑑𝑒𝑟𝑠
H𝑎𝑛𝑑𝑙𝑖𝑛𝑔 𝑓𝑒𝑒 = 24 × $300
= $7200
8

9. ANSWERS
Question 4
Bowen should order 1,000 units with the price $29 per unit.
He can save up to $2440.
Option 1 Option 2
Q= 1,000 Q= 2,000
𝑇𝐶 29
=
60 × 12,000
1,000
+
5.8 × 1,000
2
= 3620
𝑇𝐶 28.5
=
60 × 12,000
2,000
+
5.7 × 2,000
2
= 6060
TC (28.5) –TC (29) = $6060-$3620 =$2440
9
For Dr. Tareq’s further
review

10. ANSWERS
Question 5
EOQ Assumptions:
• Constant or uniform demand
• Constant unit price
• Constant carrying costs
• Constant ordering cost
• Instantaneous delivery
• Independent orders
• 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.
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.
10

11. ANSWERS
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 supplier’s firm and their product
quality control
11

12. ANSWERS
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
• 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
• 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
• Total amount of reduction of safety stock:
12

13. ANSWERS
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. Often
the costs are computed for annually and then
13

14. ANSWERS
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:
14

15. ANSWERS
• 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.
15

16. ANSWERS
• 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.
•
𝟔
𝟗
=
𝟓.𝟖
𝟖.𝟕
=
𝟓.𝟕
𝟖.𝟓𝟓
• We can see that the
preference choice depends
on the Cost per unit instead of
the percentage of carrying
cost.
16

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
17

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
18

19. SCENARIO ANALYSIS
1. If Precision Engineering dissolve the handling fee,
which supplier should Bowen choose?
𝑇𝐶 30 =
60 × 12000
500
+
6 × 500
2
= $2940
𝑇𝐶 29 =
60 × 12,000
1,000
+
5.8 × 1,000
2
= $3620
𝑇𝐶 28.5
=
60 × 12,000
2,000
+
5.7 × 2,000
2
= $6060
Bowen should
choose Precision
Engineering.
19
For Dr. Tareq’s further
review

20. 2. If Kentech also apply the special handling fee, which
supplier should Bowen choose?
𝑇𝐶 30 =
360 × 12000
500
+
6 × 500
2
= $10140
𝑇𝐶 29 =
360 × 12,000
1,000
+
5.8 × 1,000
2
= $7220
𝑇𝐶 28.5
=
360 × 12,000
2,000
+
5.7 × 2,000
2
= $7860
Bowen should
choose Kentech
and order 1,000
units.
20
For Dr. Tareq’s further
review