December 2007

Buffer inventory is where they hold extra inventory throughout the year to be safe (to reduce the risk of running out).

In this question they order when they have 35,000 units left in inventory, but on average they only use 25,000 units before the next delivery arrives. So on average they are always holding 10,000 more units than they actually usually need.

It doesn’t affect the EOQ calculations at all, but it does mean that when calculating the total holding cost over the year we need to add on the cost of holding the extra 10,000 units.

No. You need to do it the way that I wrote before 🙂

Leading is paying early, so the lead payment simply means paying the euros now, instead of waiting until it is due in 6 months time.

So we convert at the current spot.

However, in order to convert now means having to borrow money and so because of the interest the cost in 6 months time will be the money borrowed together with the interest.

(It is, of course, a silly thing for them to do – it would be more sensible to put the euros on deposit rather than pay the supplier immediately (which is what is happening with the money market hedging). Therefore it is not surprising that the lead payment is the most expensive of the three choices.