Reference no: EM13113349

Holding costs (carrying costs) represent costs associated with maintaining inventory. These costs include interest incurred or the opportunity cost of having capital tied up in inventory, storage costs, and other maintenance costs. Holding costs are expressed in terms of dollars associated with carrying one unit of inventory for one unit of time.

Ordering costs represent costs asssociated with replenishing inventories. These costs are not dependent on how many items are ordered at a time, but on the number of orders that are placed. It is typical to assume that the ordering cost is constant and is expressed in terms of dollars per order.

Q: For a manufacturing firm that you are consulting for, managers are unsure about making inventory decisions associated with a key engine component. The annual demand is estimated to be 15,000 units and is assumed to be constant throughout the year. Each unit costs $80. The company's accounting department estimates that its opportunity cost for holding this item in stock for one year is 18% of the unit value. Each order placed with the supplier costs $220. The company's policy is to place a fixed order quantity Q units whenever the inventory level reaches a predetermined reorder point that provides sufficient stock to meet demand until the supplier's order can be shipped and received. As a consultant your task is to develop and implement a decision model to help them arrive at the best decision. Specifically:

1. Define the data, uncontrollabel inputs, and decision variables that influence total inventory cost.
2. Develop mathematical functions that compute the annual ordering cost and annual holding cost based on average inventory held throughout the year in order to arrive at a model for total cost.
3. Implement your model on a spreadsheet.
4. Use data tables to find an approximate order qty that results in the smallest total cost.
5. Use solver to verify your results.