Question

A. You run a business, located in a populous Western United States mountain community that sells outdoor adventure equipment such as backpacks and high-altitude clothing, and other camping and climbing gear. One of your prominent suppliers of backpacks is offering a significant discount on the new season model of backpack that is particularly popular to climbers in the area and throughout the United States. They will offer a 25% discount on the usual wholesale cost of these backpacks to your business, however you must purchase two times the usual number of backpacks in a single order (volume purchasing). 1. Without worrying about actual numbers, briefly describe the advantages and disadvantages of taking this discount on the high-volume purchase, particularly from the perspective of managing your working capital. 2. Describe what Economic Order Quantity is and what information you need to compute it. 3. Describe the Just-in-Time model of ordering inventory 4. Do you think these models work for someone who runs a business that sells such perishable items and goods as a restaurant?

Answer 1

(1): The advantages of taking this discount on the high-volume purchase is that it will only block the working capital once and in future the working capital will be freed up as the inventory is liquidated. In terms of disadvantage a substantial amount of working capital will be blocked as double the amount of usual inventory is being purchased. Further extra space will be needed for storing the inventory and this will increase the holding cost of the inventory.

(2): Economic order quantity (or EOQ) can be defined as that that order quantity that leads to minimization of inventory costs. It should be noted that inventory costs consists of holding costs, shortage costs, and order costs. The information that is needed to compute EOQ is information with regards to annual demand for the product, ordering costs per purchase order and holding cost of one unit per year.

(3): Just in time (JIT) model of ordering inventory is that model in which labor, materials and goods are scheduled to arrive at a point in time which is exactly when required by the manufacturing process. The model aligns raw material orders from the suppliers directly with production schedules. This model leads to increased level of efficiency and ensures decline in wastes as goods are received only when required by the production process. This reduces the inventory costs.

(4): The EOQ model will not work very well for someone who runs a business that sells such perishable items and goods as a restaurant. This is because the objective in such a case in which perishable items are in question is to ensure that the perishable items do not suffer from any spoilage. On the other hand just in time model will be good for the restaurant business as it will ensure that its ingredients are fresh and will be used before they get spoiled.