Question

Garden Variety Flower Shop uses 630 clay pots a month. The pots are purchased at $2.60 each. Annual carrying costs per pot are estimated to be 40 percent of cost, and ordering costs are $25 per order. The manager has been using an order size of 1,250 flower pots.
a. What additional annual cost is the shop incurring by staying with this order size?
b. Other than cost savings, what benefit would using the optimal order quantity yield (relative to the order size of 1,250)?

Answer 1

Answer:

See attached file

Explanation:

Answer 2

Answer:

a) Additional annual cost = $174.21

b) Additional benefits

1. It will also help the company to evaluation of  quantity discount offers of the supplier.
2. Supports better stock replenishment

Explanation:

The additional annual cost i the difference between the Inventory cost using EOQ and the current order size

Total relevant cost is made up of

1. Annual ordering cost= (Demand/order size) × Ordering cost per order
2. Carrying cost = holding cost per unit per annum × order size/2

Inventory cost using the current order size

Carrying cost = (1,250/2  ×40% × $2.60) = 650

Ordering cost = (630× 12)/1250 ×  $25 = 151.2

Total cost =$801.2

Inventory cost using Economic order quantity (EOQ)

The Economic Order Quantity (EOG) is the order size that minimizes the balance of ordering cost and holding cost. At the EOQ, the carrying cost is equal to the holding cost.

It is computed using he formulae below

EOQ = (2× Co× D)/Ch

EOQ = √(2×25 ×630× 12)/(40% ×2.60)

        = 602.87 units

Carrying cost =(602.87/2  ×40% × $2.60) = 313.49

Ordering cost = (630× 12)/ 602.87 ×  $25  = 313.49

Total cost =313.49 + 313.49 =  $626.99

Additional annual cost = $801.2 - $626.99 = $174.21

Additional benefits

1. It will also help the company to evaluate any potential quantity discount being offered by its supplier. Sometimes, suppliers do offer discount for order n excess of the EOQ. So these offers would be best evaluated against the EOQ
2. EOQ makes replenishment of  stock very easy therefore helping to meet needs of the customers better