ExpertHard2 marksMultiple Choice
ACCA · Question 09 · Working Capital Management
Section A
CityWater is a public utility company that requires 50,000 units of a specific chemical annually for water treatment. The cost of placing an order is $100. The holding cost per unit per year is $4.
Using the Economic Order Quantity (EOQ) model, what is the total annual cost of ordering and holding inventory if the company orders exactly the EOQ? (Ignore the purchase cost of the chemical).
Section A
CityWater is a public utility company that requires 50,000 units of a specific chemical annually for water treatment. The cost of placing an order is $100. The holding cost per unit per year is $4.
Using the Economic Order Quantity (EOQ) model, what is the total annual cost of ordering and holding inventory if the company orders exactly the EOQ? (Ignore the purchase cost of the chemical).
Answer options:
A.
$3,162
B.
$6,325
C.
$1,581
D.
$12,650
How to approach this question
First, calculate the EOQ using the formula sqrt((2*C0*D)/Ch). Then, calculate total annual holding cost (EOQ/2 * Ch) and total annual ordering cost (D/EOQ * C0). Add them together.
Full Answer
B.$6,325✓ Correct
1. Calculate EOQ: sqrt((2 * 50,000 * 100) / 4) = sqrt(2,500,000) = 1,581.14 units.
2. Calculate Annual Holding Cost: (Average Inventory) * Holding Cost = (1,581.14 / 2) * $4 = $3,162.28.
3. Calculate Annual Ordering Cost: (Number of Orders) * Order Cost = (50,000 / 1,581.14) * $100 = $3,162.28.
4. Total Cost = $3,162.28 + $3,162.28 = $6,324.56 (Rounds to $6,325).
Common mistakes
Calculating the EOQ and selecting that number (Option C) instead of calculating the costs.
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