March 20 – Zar Co. – Cost of Inventory ordering policy

Hi sir

Just first to thank you for going through multiple exam style MCQs in your youtube channel, it has been really helpful in this revision stage.

Just a quick query:

Example 1
The inventory ordering policy of ZAR Co is to order 100,000 units when the inventory level
falls to 20,000 units. The cost of placing and processing an order is $200, while the cost of
Examiner’s report – FM March 2020 8
holding inventory is $0.50 per unit per year. Orders are received one week after being
placed with the supplier. The production requirement for the next year (50 weeks) is
600,000 units

The correct answer is $30200
Ordering cost = $200 x (600,000/100,000) = $1,200 per year
Consumption during one week lead time = 600,000/50 = 12,000 units
Buffer inventory = re-order level less lead time usage = 20,000 – 12,000 = 8,000 units
Average inventory held during the year = 8,000 + (100,000/2) = 58,000 units
Holding cost = 58,000 x $0·50 = $29,000 per year
Total cost = ordering cost plus holding cost = $1,200 + $29,000 = $30,200 per year

I dont understand the logic of where the “100,000/2” comes from , is that going to be always the calculation for average inventory held ? Buffer level + (Number of items per batch /2 )

Thank you !