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EE co has calculated the following in relation to its inventories :
Buffer inventory level 50 units
Reorder size 250 items
Fixed order costs 50 per order
Cost of holding onto one item pa 1.25 per year
Annual demand 10000 items
Purchase price 2 per itemWhat are the total inventory related costs for a year?
The kits answer for holding cost takes the buffer inventory level plus reorder size /2 multiplied by 1.25
But why do we take the reorder size instead of total demand of units for the year?
Please explain it.
The total demand of 10,000 is not the amount of inventory being held all year.
The are ordering 250 units each time and so the level of inventory will fluctuate during the year between 250 (when an order has just been received) and 0 (when they have sold it all and are about to receive another order). So on average there will be 125 units in inventory throughout the year (plus, of course, the buffer inventory).
Do watch my free lectures on inventory (and the Paper MA (was F2)) lectures on inventory also, because this is revision from Paper MA.
Thank you so much!! You can explain it really well and I have understood the logic now.
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