Inventory and Total Holding Costs

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Mabuhay Products Inc.Submitted by:Michelle MolasAdrian ManlapigAngela NunezKatrina Silvoza|

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Point of View_________________________

This case was analyzed from the point of view of Robert Ocampo, the inventory manager of Mabuhay Products Incorporated.

Case of Context_______________________

Mabuhay Company Incorporated owns 50 grocery outlets scattered around the metro but has only one main warehouse where all the goods are stored prior to delivery. The current inventory policy of the company had been practiced for the past 15 years. It mandates the monthly reorder of stocks by the main warehouse, and charging the branches with the delivery cost and a 3% financing charge per month on their inventory costs. The latter policy serves as the warehouse’s control system to the branches such that they maintain “just right” inventory.

However, the company is now getting concerned as to whether their warehouse capacity can accommodate the possible sales increase. Management is alarmed as to the possible implication of the booming sales to inventory levels in the Valenzuela warehouse and the associated costs attributable to inventory.

In order to address this pressing problem, the company’s vice-president for operations, Mr. Paul dela Cruz was tasked to assess the inventory level of Mabuhay company, as well as establish better policies with regard to inventory management. Mr. Robert Ocampo, the inventory manager of the company was appointed by the VP to make a cost analysis of the company’s inventory. Their study is aimed towards the formulation of criteria that would guide management as to the optimal order quantity, and reorder point for both products with predictable and unpredictable sales demand.

Problem___________________________

1. Using product A as a starting point, come up with a detailed study that will help establish needed criteria in deciding how much to order and when to place and order, at the same time minimizing inventory cost. 2. Given that the demand for product is unpredictable, what inventory policy can be imposed? 3. In July 1997, the peso depreciated against the US dollar from P26 to $1 to P30 to US$ 1. Mr. Paul dela Cruz is considering to stock up on product A, an imported item. He is afraid that the competitors will be doing this and might under-price product in the market should the exchange rate deteriorate further to P35 to US$1 during implications of holding safety stock equivalent to three months sales.

Framework__________________________

In order to answer the problems, the following steps were undertaken: 1. Since the demand for Product A is fairly stable, use the EOQ model to compute for the minimum inventory cost. 2. Establish criteria for Product B inventory policy to avoid stockouts. 3. Construct a cost-benefit analysis of ordering 3 months worth of safety stock to evaluate the tradeoff concerned.

#1

For Product A, We applied the concept of Economic Order Quantity to identify how much to be order and when to order. The EOQ or Q* represents the amount of units to be ordered per order wherein inventory costs (holding costs and order costs) are minimized. It is computed as follows:

Q* =2DS÷Ch

Where,
D = expected annual demand = 2,000 x 12mos. = 24,000
S = order cost per order = Php50
H = holding cost per unit per year = Php1,200 x 6% = Php72

Hence, the EOQ for Product A is:

Q* =224,00050÷72= 182.57 or 183 units

Since the actual usage varies from the expected demand, Safety Stock in excess of EOQ is also computed:

Z= SSσ

Where,
Z = Z-value of the company’s chosen service level = 1.65
SS = safety stock
σ = standard deviation of actual usage from expected demand = 42

For the service level, the group has chosen 95% arbitrarily. Accordingly, the Z-table gives a Z-value of 1.65 for a 95% service level.

Meanwhile, in computing for the standard deviation, only positive errors (actual usage >...
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