Question

A manager at a manufacturing factory must choose between two shipping alternatives: 2 day freight and 5 day freight. Using 5 day freight would cost $120 less than using 2 day freight. The primary consideration is the holding cost which is $12 per unit per year. 2000 items are to be shipped. Which alternative would you recommend? EXPLAIN

Answer 1

I would recommend the 2-day freight.

Reason:

Holding cost per unit per year= $12

No of items to be shipped = 2000

Hence total holding cost per year, H = 2000 x 12 = $24000

Difference in days between two day and five day freight = 3 days

Incremental holding cost incurred by using slower alternative= H(d)/365

                                             = 24000(3)/365

                                             = $197.26

Five day freight would cost only $120 less than the two day freight. Hence we can find that the actual savings by using five day freight is less than its incremental holding cost of $197.26. Hence use of two-day freight alternative would provide cost advantage.