Lgt 3105 Operations Management - Individual Assignment Case Study – Jamie Chang

LGT3105 
OPERATIONS MANAGEMENT

Individual Assignment

Case Study – Jamie Chang

Group 266

Lecturer: Jiang Li

Q1. Are the EOQ calculations correct?

To examine whether or not the EOQ calculations are correct, the way how to calculate the EOQ should be considered. EOQ is the Economic Order Quantity, which is the level of inventory that minimizes the total inventory holding costs and ordering costs. The formula of calculating the EOQ is[pic 1]. In this formula, D is the annual demand quantity, S is the setup cost per order, H is the annual holding cost and Q* is the optimal order quantity. To examine the accuracy of the EOQ calculations, three components of the formula should be examined. They are the (a.) annual demand (D), (b.) setup cost (S) and (c.) holding cost (H).

1. Annual demand

About the annual demand of the company, it is given that the figures of 75 products obtained by Chang were quite reliable over a period of several years. Also, these data were included the adjustment of scrap, testing, and pilferage loss percentages provided by Industrial Engineering. These figures were generally agreed to be the best possible estimates of future demand on the injection molding departments for each of these products. Therefore, there is a reasonable ground for agreeing the annual demand is quite accurate.

1. Setup cost

Setup cost is the cost that incurred each time when the orders were received. The cost is not associated with how many quantities the company ordered, it is related to the activities needed to process and place the order.

In the case, the cost was calculated by using the setup cost per hour multiplied by setup hours per order. Jamie’s calculation composed of three workers. One of them is a full time employee with an annual equivalent to $9.00 per hour (based on the standard 8 hours a day and 300 days a year) and two of them are paid an hourly rate of $5.00. Jamie’s result is $19.00 setup cost per hour ($5 * 2 + $9).

However, one of the three employees is a full-time worker, it is doubted that whether or not this worker’s salary need to be considered. Even though the company does not need to order any inventory, his salary still has to pay. Also, the worker’s salary may not be only related to the setup activities, it is possible that he can be rotated to other departments when he is spare. Another reason should be considered is that the worker may have a contract with the company, the salary is paid based on the contract, but not incurred by the setup activities. Therefore, the fixed salary of this worker can be considered as a sunk cost, similar to the cost of the administrative staff. The $9.00 fixed cost should be excluded in the setup cost per hour. As a result, the setup cost per hour will be $10.00 only ($5 * 2).

1. Holding cost

Holding cost is the cost that incurred when the company is holding inventories. It included the sum of the cost of capital, shrinkage and obsolescence cost, insurance and year-end inventory tax. To compute the holding cost, the product unit cost and the holding cost percentage should be collected. Therefore, to examine the accuracy of the holding cost, both the product unit cost and the holding cost percentage should be examined.

In the Jamie’s calculation, the state tax, inspection cost, variable overhead, and fixed overhead allocation had deducted from the full unit cost and had used the resulting figure as unit cost in the EOQ formula. However, this calculation contained some problems. Deducting the tax rate is appropriate as the tax liability is not incurred until the sale of the finished products. Also, excluding the fixed allocation is appropriate because it is actually the sunk cost, and it does not associated with the inventory’s quantity.

About the inspection and variable cost, both of them should not be excluded. If the quantity of inventory increases, these two costs will be increased accordingly. Therefore, it should be taken part in the calculation.

The new product unit cost should be as the following:

About another component – the holding cost percentage, in Jamie’s calculation, 22% was used and was the appropriate holding cost percentage for the EOQ model.