Fixed order quantity model

DQ #1: How can inventory carrying cost be calculated for a specific product? What suggestions would you offer for determining the measure of product value to be used in this calculation?

Inventory carrying costs consist of four parts: capital cost, storage space cost, inventory service cost, and inventory risk cost (Coyle et al, 2017). Capital costs are the opportunity costs of cash that is in the physical inventory. If capital was borrowed to invest in the inventory, there are additional costs in the form of dividends or interest. The capital costs are generally represented as a percentage of the dollar value of the inventory on hand (Coyle et al, 2017). Capital costs are also usually the largest portion of inventory carrying costs. Storage space costs consist of rent, utilities, and handling costs for moving product in and out of inventory (Coyle et al, 2017). Storage space costs increase or decrease as inventory levels increase or decrease so variable costs instead of fixed costs should be used to estimate storage space costs. Inventory service costs consist of insurance and taxes on the inventory (Coyle et al, 2017). Inventory risk costs consist of costs associated with obsolescence, theft, or quality deterioration of inventory (Coyle et al, 2017). Some inventory has higher risk than others such as technology inventory risks obsolescence issues before selling, luxury/expensive inventory risks theft, and fresh produce or meat risks quality deterioration. According to Coyle, Langley, Novack, and Gibson, “The extent to which inventoried items are subject to such risks will affect the inventory value thus the carrying cost” (2017).

Two ways to determine product value is hurdle rate and weighted average cost of capital (Coyle et al, 2017). The hurdle rate is the minimum rate of return on new investments. This is beneficial because organizations can make decisions on inventory the same way they make decisions on investments and advertising. The weighted average cost of capital is “the weighted average percent of debt service of all external sources of funding, including both equity and debt” (Coyle et al, 2017). This is beneficial because it reflects the debt service costs of having capital tied up in inventory.

DQ#2: Compare and contrast the fixed quantity version of EOQ with the fixed interval version. In which situations would each be used?

The fixed order quantity model is when an organization orders a fixed amount of stock each time it places an order (Coyle et al, 2017). Organizations that use the fixed order quantity model determine a set inventory level (reorder point) for when a new order needs to be placed. When inventory levels reach the reorder point, the fixed order quantity is ordered from the supplier. The inventory level at the reorder point is determined by lead time and demand during lead time. Organizations want to be sure that the reorder point quantity is enough to cover demand during lead time. The fixed order quantity model is good for items that have uncertain demand patterns because organizations are free to order stock whenever a new order is needed.

The fixed order interval model is when an organization orders inventory at a fixed interval (Coyle et al, 2017). The quantity that is ordered depends on how much stock is on hand at the fixed order interval. The fixed order interval method requires less monitoring of inventory levels than the fixed order quantity model (Coyle et al, 2017). The fixed order interval model is good for items that have stable demand patterns because an unexpected increase in demands could cause a stock out depending on how close the fixed order interval is.