The orders are placed at equally spaced times t 1 and

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The orders are placed at equally spaced times T 1 and T 2 . For example, at time T 1 where the actual level of inventory is 11 and order of size (R.I 1 ) is placed. 0 R* I 0 I 1 I 2 INVENTORY LEVEL R* -I 1 R* -I 2 T 0 T T 1 T 2 T LEAD TIME LEAD TIME TIME Fig. 14.3 The Changes Of Inventory Level For The Periodic Order Model 14.3.9 INVENTORY COSTS As was stated earlier, inventory models are quantitative formulas. These formulas consider various inventory costs. Only those costs that vary as the inventory decisions of “when” and “how” change should be considered. Costs that are fixed and independent of how much or when to order are not considered in developing the models. Operations managers should identify these costs and then minimize their total. The costs are of five types: a) Item cost b) Ordering cost c) Costs of carrying inventory d) Stockout costs associated with shortages e) Fixed overhead costs The costs vary from one product to another but their nature stays the same. 14.3.9.1 Item Cost Item cost is the purchase cost or the value of the item to the inventory holder. Whether at book value or market value, the item cost does not affect the reorder
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192 decision if there are no quantity discounts. If there are quantity discounts, then the item cost has an impact on the reorder decision, because the larger the order is, the lower is the cost per single unit purchased. 14.3.9.2 Ordering Cost Ordering cost includes all the necessary expenses involved in placing one order. This cost is assumed to be constant and is incurred each time an order is placed. If this cost becomes very large, one would prefer placing a large order once or twice a year. The ordering cost includes clerical and paper work expenses, incoming inspection, book keeping, records updating, expediting expenses, postage, and delivery costs. The average procurement cost can be found from accounting records by totaling the annual costs of the above items and dividing by the number of orders placed throughout the year. 13.3.9.3 Carrying inventory cost Carrying inventory costs are costs that reflect the investment in inventory and the costs associated with maintaining it in storage. A higher inventory level may require an expansion of warehouse, increased material- handling costs, and increased maintenance costs. The costs may be extracted from the accounting records. Items that should be considered are: a) Capital cost b) Storage costs: land and building costs and rent c) Service costs: (inventory taxes, insurance, material handling) d) Risk costs: Obsolescence and shrinkage (Pilferage, damage, spoilage, theft) The most significant cost among those is the capital cost. It may constitute anywhere from 49% to 96%of the total carrying costs. The capital cost is either: a) The average cost of borrowing (interest) to the company b) The marginal cost of borrowing to the company c) The return on an alternative investment that is not realized due to the fact that money is tied up in inventory.
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