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Dear John,
I have a doubt about the way BPP calculates discount in this exercise:
A company uses an item of inventory as follows.
Purchase price $25 per unit
Annual demand 1,800 units
Ordering cost $32
Annual holding cost $4.50 per unit
EOQ 160 units
What is the minimum total cost assuming a discount of 2% given on orders of 300 and over?looking at exercises done in your lectures you – rightly, according to me – apply the 2% discount on both selling price and holding cost per annum. Talking about holding cost it was a % on the selling price, so that it is sensible to apply a discount to the selling P and then calculate the holding cost.
What does seem wrong to me is the way bpp applies discount in this exercise. It applies 2% on the purchase cost (and it’s ok), but it is done also with the annual holding cost, and here it is reported as a 4.50 per unit, not as a % of the selling P. What do you think about it? what does the supplier have to do with the unit cost of holding inventory?
thanks again for your precious help
EIf in the exam the holding cost is given in $’s, then it stays the same (per unit) whether or not there is a discount.
If, on the other hand, the holding cost is given as a % of the purchase price, then if the purchase price is lower (because of the discount) then the holding cost per unit will be lower as well.
(The logic behind it being given as a % of purchase price is that the most important cost of holding inventory is the interest cost on the money tied up in inventory. If the inventory costs less then there is less money tied up and therefore less interest.)
Ok, so you are confirm that BPP revision kit could be wrong in showing
Holding cost for one unit of inventory for one year = $4.50 × 98% = $4.41
? holding costs = 150 units × $4.41 = $661.50in the exam I will follow your ex and mantain 4.50 per unit
Thank you very much
E
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