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Hi Sir,
Hope you are doing well.
I came across this question in Kaplan Kit:
“The production manager has established the following information about a major inventory item.
Purchase price per unit $480
Annual demand 4,000
Supplier’s delivery costs per order $10
Chief buyer’s salary per annum $30,000
Total number of orders placed per annum* 1,000
Annual storage costs per unit $2
Cost of capital 10% per annum*Relates to all product lines, not just this one.
What is the economic order quantity for this inventory item?”
In their answer for EOQ, the denominator Ch is calculated by $2+10%*$480 = $50, and thus EOQ = 40 instead of 200 (if just use $2).
I don’t think I have seen this cost of capital mentioned in your notes or BPP book before, so quite confused by this answer.
Could you help explain this, please?
Thank you so much.
As I do state in my free lectures, the most likely cost in practice of holding inventory is the interest cost of the money tied up in inventory.
If the cost of capital is 10%, then the interest cost of having $480 tied up in one unit of inventory for one year is 10% x $480.
I hope that you are not using our free notes without watching the lectures that go with them. They are only lecture notes, and it is in the lectures that I work through the examples and expand and explain on the notes.
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