Question 17-7

Goal congruence issues arise when there is an inconsistency between the EOQ decision model and
the model used for evaluating the performance of the person implementing the model. For
example, if opportunity costs are ignored in performance evaluation, the manager may be
induced to purchase in a quantity larger than the EOQ model indicates is optimal.
Question 17-11
Supply-chain analysis describes the flow of goods, services, and information from the initial
sources of materials and services to the delivery of products to consumers, regardless of whether
those activities occur in the same organisation or in other organisations. Sharing of information
across companies enables a reduction in inventory levels at all stages, fewer stockouts at the
retail level, reduced manufacture of product not subsequently demanded by retailers, and a
reduction in expedited manufacturing orders. Socially responsible supply chain management
involves recognising a responsibility to choose suppliers with satisfactory social and
environmental performance. External reporting systems, such as the Global Reporting Initiative
(GRI) require organisations to consider the social and environmental performance of their
suppliers that they have direct or indirect influence over. Being associated with suppliers that
have poor social and/or environmental performance can be very damaging to an organisations
reputation. It can also lead to unreliable supply if the supplier faces legal action, employee action
(e.g., strikes), or consumer action(e.g., boycotts).
Exercise 17-19 EOQ for manufacturer
1.
Relevant carrying costs per part per year:
Required annual return on investment 13% $35 =
Relevant insurance, materials handling, breakage, etc.
costs per year
Relevant carrying costs per part per year

$ 4.55
9.5
$14.05

With D = 19 000; P = $175; C = $15, EOQ for manufacturer is:

2 27500 $125
$14.05
=

= 699.51 =700 units

D
P

Total relevant
ordering costs
2.

27500

$125

700

=
= $4 910.71
where Q = 700 units, the EOQ.
3. At the EOQ, total relevant ordering costs and total relevant carrying costs will be exactly equal. Therefore, total relevant
carrying costs at the EOQ = $4910.71 (from requirement 2). We can also confirm this with direct calculation:

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Total relevant carrying costs

=

C
2

700

$14.05

=
= $4 917.50
where Q = 700 units, the EOQ. The slight difference is due to rounding the EOQ from
699.51 to 700.
4.

Purchase order lead time is one week.

Monthly demand is 27 500 units
Demand in a week is 27 500/52 = 528.8 or 529units

Landsborough Lawns should reorder when the inventory of rotor blades falls to 6346 units.
Exercise 17-22 JIT production, relevant benefits, relevant costs
1.
Solution Exhibit 17-22 presents the annual net benefit of $282 000 to Harris Hardware
Company of implementing a JIT production system.
2.

Other nonfinancial and qualitative factors that Harris should consider in deciding whether it
should implement a JIT system include:
a. The possibility of developing and implementing a detailed system for integrating the
sequential operations of the manufacturing process. Direct materials must arrive when
needed for each subassembly so that the production process functions smoothly.
b. The ability to design products that use standardised parts and reduce manufacturing
time.
c. The ease of obtaining reliable vendors who can deliver quality direct materials on time
with minimum lead time.
d. Willingness of suppliers to deliver smaller and more frequent orders.
e. The confidence of being able to deliver quality products on time. Failure to do so would
result in customer dissatisfaction.
f. The skill levels of workers to perform multiple tasks such as minor repairs,
maintenance, quality testing and inspection.

Solution Exhibit 17-22

Annual Relevant Costs of Current Production System and JIT Production System
for Harris Hardware Company
Relevant
Relevant
Costs under
Costs
Current
under JIT
Production
Productio
Relevant Items
System
n System
Annual tooling costs

$105 000
Required return on investment:
12% per year $750 000 of average inventory per year
$90 000
12% per year $112 500a of average inventory per year
13 500
Insurance, space, materials handling, and setup costs
350 000
287 000b
Rework costs
150 000
82 500c
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Incremental revenues from higher selling prices

Total net incremental costs
Annual difference in favour of JIT production

(180 000)d
$590 000
$308 000
$282 000

$750,000 (1 85%) = $112 500

b$350,000 (1 0.18) = $287 000
a

c$150,000 (1 0.45) = $82 500

d$4 45,000 units = $200 000

3.
Personal observation by production line workers and managers is more effective in JIT plants
than in traditional plants. A JIT plants production process layout is streamlined. Operations are
not obscured by piles of inventory or rework. As a result, such plants are easier to evaluate by
personal observation than cluttered plants where the flow of production is not logically laid out.

Besides personal observation, nonfinancial performance measures are the dominant methods of
control. Nonfinancial performance measures provide most timely and easy to understand
measures of plant performance. Examples of nonfinancial performance measures of time,
inventory, and quality include:
Manufacturing lead time

Units produced per hour

Machine setup time manufacturing time
Number of defective units number of units completed

In addition to personal observation and nonfinancial performance measures, financial

performance measures are also used. Examples of financial performance measures include:
Cost of rework

Ordering costs

Inventory turnover (cost of goods sold

Stockout costs

average inventory)

The success of a JIT system depends on the speed of information flows from customers to
manufacturers to suppliers. The Enterprise Resource Planning (ERP) system has a single
database, and gives lower-level managers, workers, customers, and suppliers access to operating
information. This benefit, accompanied by tight coordination across business functions, enables
the ERP system to rapidly transmit information in response to changes in supply and demand so
that manufacturing and distribution plans may be revised accordingly.
Problem 17-28
Effect of management evaluation criteria on EOQ model

2 25000 $175
251.20
1. EOQ = =
= 186.635 tablets = 187 (rounded up)
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2. Number of orders per year = =

Total relevant = D P
ordering costs Q

Total relevant
C
=

carrying costs
2

25 000/187 = 133.69 orders

25000

$175

187

= $23,395.72*

187

$251.20

= $23,487.20*

Total relevant cost = $23 395.72 + $23 487.20 = $46 882.92

*Difference is due to rounding up the units in an order

2 25000 $175
$170
3.

EOQ = =
= 226.87 or 227 (rounded up) tablets
= 25 000/ 227 = 110.13 or 111 orders

Total relevant =
ordering costs

D
Q

Total relevant = Q C

carrying costs 2

25000

$175

227

= $19,273.13

227

$170.00

= $19,295*

*Note that the opportunity cost is not included in this calculation. If the opportunity cost is included in the total relevant
carrying costs they would be:

Total relevant =
carrying costs

227

$251.20

= $28,511.20

Total relevant cost = $19 273.13 + 19 295.00 = $38,567.13

Total relevant costs with opportunity cost included = 19 273 + 28 511.20* = 47 784.20
* this is the carrying cost with the opportunity cost included

If an EOQ of 187 tablets is used the total relevant costs, with the opportunity cost included,
Thus, the EOQ quantity and total relevant costs are higher if the company ignores holding costs
when evaluating managers. The square root in the EOQ model reduces the sensitivity of the
ordering decision to errors in parameter estimates.
4. Managers will choose to order 227 tablets instead of 187. When opportunity costs are
excluded, the cost to Netlets will seem to be lower when the order size is larger
(46 882.92 for 187 tablets compared to 38 567.13 for 227 tablets). When opportunity costs are
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included, the total cost is $46 882.92 (see part 2) for 187 tablets and
$47 784.20 (see part 3) for 227 tablets which means that an order size of 227 costs the company
$847 more. Netlets probably does not include the opportunity costs of carrying inventory because
it is not tracked by the financial accounting system. The company could change the evaluation
model to include a cost of investment in inventory. Even though this would involve an additional
calculation, it would encourage managers to make optimal decisions.

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