Chapter 4 - Inventory Management

Question 1

strategic motives influencing corp inv levels

Answer 1

1. transactions motive
2. precautionary motive
3. speculative motive

Question 2

Transactions motive

Answer 2

carrying inv to meet day to day demand

Question 3

Precautionary motive

Answer 3

inventory is held to mitigate the negative effects of adverse conditions

Question 4

Speculative motive

Answer 4

represents the strategy of carrying inv to take advantage of unforeseen opportunities

Question 5

Why is inventory a difficult item to manage?

Answer 5

because it crosses so many lines of responsibility, such
as the purchasing, production, marketing, and treasury departments.
- The purchasing manager
oversees the supply of raw materials and would like to purchase in bulk to take advantage of quantity
discounts.
- The production department seeks to ensure that the manufacturing process is
uninterrupted by keeping enough raw materials and work in process inventory on hand to mitigate
unforeseen contingencies.
-The marketing function oversees advertising and wishes to minimize the
likelihood of stock-outs (i.e., running out of inventory).
- The treasury department is concerned
with achieving an appropriate rate of return on invested capital. Funds tied up in inventory cannot
be invested in other assets and are thus considered idle funds.

Question 6

Operating motives that influence inv levels

Answer 6

1. Uncertain customer demand
2. Variability in the supply and price of necessary inputs
3. Economies of scale in purchases

Question 7

Uncertainty customer demand

Answer 7

Customer demand is largely variable
When demand is higher than expected, firm may experience stock outs and lose business b/c customers go elsewhere to make purchases, thus firms will carry more inv as a buffer

Question 8

Variability in the supply and price of necessary inputs

Answer 8

The supply of RM used in the production process is volatile as is the future price of inputs. Inv provides a hedge against both of these uncertainties. In addition, the seller’s production schedule contains some degree of variability due to potential breakdowns and labor difficulties.

Question 9

Economies of scale in purchases

Answer 9

Firms may receive quantity discounts when making bulk

purchases

Question 10

Total cost of managing inv has 2 components:

Answer 10

1. Ordering costs
2. Holding costs
   Total costs is = individual order costs times the # of orders placed during the period

Question 11

of orders =

Answer 11

inventory demanded divided by # of units requested per order

Question 12

Inv holding cost =

Answer 12

Avg inv balance held over the planning period (amount of inv ordered/2) x the estimated per unit holding cost

Question 13

Total cost of holding inc (TCinv)

Answer 13

(F)(T/Q) + (H)(Q/2)
[(Fixed order cost per order) x (Total inv units demanded/Order quantity)]
+ [(holding cost per inv unit) x (order quantity/2)]

Question 14

Trade-off of ordering vs/ holding costs

Answer 14

Larger order quantity reduces ordering costs by lowering the # of orders places
But, a larger order quantity results in a larger holding cost by increasing the size of the avg inv balance

Question 15

EOQ (Economic Order Quantity)

Answer 15

The order quantity that minimizes the total cost of managing inventory:
Sqr Root of [(2)(T)(F)/(H)]
Where:
T = Total inv units demanded
F = Fixed order costs per order
H = Holding costs per inv unit

Question 16

The EOQ is derived by

Answer 16

differentiating the TC equation with respect to the OQ and setting the 1st derivative equal to 0 in order to located the minimum point on the total cost curve

Question 17

Important information that can be derived from the EOQ

Answer 17

1. # of order placed(total inv units req/EOQ)
2. Avg Inv balance
   (EOQ/2)

Question 18

Inv usage rate

Answer 18

The total inv units required/# of days in the production period

Question 19

optimal reorder point

Answer 19

The point at which orders should be placed

= daily usage rate x # of days it takes to receive a shipment

Question 20

Safety stock

Answer 20

protects the firm from running out of inv if sales are not stable or the production or delivery times are uncertain or unreliable
*reorder point w/ safety stock is DUR x # of days to receive shipment + safety stock

Question 21

Restrictions of the EOQ model

Answer 21

It has restrictive assumptions inc:
1. perfect forecasts of inv units demanded
2. a constant rate of inv usage
3. fixed ordering and holding costs
Cannot be used as a standalone measure of setting inv policy because it ignores fluctuation in costs, demand, and risk

Question 22

Two approaches to monitoring the inv balance:

Answer 22

1. Inventory turnover approach

2. Balance fraction approach

Question 23

Inventory turnover approach

Answer 23

based on the inventory turnover ratio
= Period COGS/Period inv balance
Shows the # of times cycled through inv in the period
Also can arrive at this number by dividing 365 by the DIH

Question 24

Balance fraction approach

Answer 24

An improvement on the Inv turnover approach b/c it provides greater detail to the flow of inv over time
Develop monthly balance fractions based on the proportion of items remaining in inventory from a given month’s purchase