Chapter 14

Question 1

Reasons for holding inventory

Answer 1

To meet demand by acting as a buffer in times of unusually high consumption (i.e. to reduce the risk of “stock-outs”).
To ensure continuous production.
To take advantage of quantity discounts.
To buy in ahead of an expected shortage or ahead of an expected price rise.
For technical reasons (e.g. maturing whiskey in casks or keeping oil in pipelines).
To reduce ordering costs

Question 2

Inventory costs

Answer 2

Holding costs:
cost of capital tied up;
insurance;
deterioration, obsolescence and theft;
warehousing; and/or
stores administration.
Re-order costs:
transport costs;
clerical and administrative expenses; and/or
batch set-up costs for goods produced internally.
Shortage costs:
production stoppages caused by lack of raw materials;
stock-out costs for finished goods (e.g. lost sale); and/or
emergency re-order costs.
Systems costs − people and computers

Question 3

Economic order quantity

Answer 3

– the optimal order quantity that minimises the total costs which are relevant to ordering and holding inventory.

Question 4

Assumptions of EOQ

Answer 4

Purchase price per unit is constant.
Constant demand.
No risk of stock-outs.
Holding cost depends on average level of inventory.

Question 5

Is cost of holding inventory a finance cost .

Answer 5

Yes

Question 6

Reorder level

Answer 6

the level to which inventory should fall before placing a purchase order for replenishment.

Question 7

Lead time

Answer 7

the time between placing and receiving an order

Question 8

Constant demand

Answer 8

Re-order level (ROL) = lead time (days) × demand per day

Question 9

Just in time system for purchasing system

Answer 9

A just-in-time purchasing system aims to minimise the cost of holding inventory by placing orders so that the timing of delivery is when the goods are needed

Question 10

Just in time for production system

Answer 10

A JIT production system aims to minimise the cost of manufacturing by only producing goods as they are needed.

Question 11

Conditions to be met for JIT

Answer 11

Flexibility of both suppliers and internal workforce to expand and contract output at short notice.
Raw material inventory must be of guaranteed quality −
Close working relationship with suppliers and, if possible, geographical proximity in order to make immediate deliveries.
A low inventory level normally requires short production runs. This is only appropriate, therefore, where set-up costs are low. High-technology production methods have made this easier to achieve.
The workforce must be willing to increase or decrease its working hours from one period to another. This could be done by having a core workforce with a group of part-time or freelance workers.
The design of the factory must be such that JIT deliveries to all areas are possible.
Total reliance on suppliers for quality and delivery, and therefore very tight contracts with penalty clauses.
Significant investment by suppliers, and therefore long-term contracts.