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Nyali Ltd. is a distributor of an industrial chemical in the South Coast. The chemical is supplied in drums which have to be stored at a...

      

Nyali Ltd. is a distributor of an industrial chemical in the South Coast. The chemical is
supplied in drums which have to be stored at a controlled temperature. The
company‟s objective is to maximize profits, however the management team disagrees on
the stock control policy and holds the following different views:
The Managing Director's view:
The company's managing director (MD) wishes to improve the stock holding
policy by applying the economic order quantity (EOQ) model. Each drum of the chemical
costs Shs. 5,000 from a supplier and is sold for Shs. 6,000. The annual demand is estimated
to be 10,000 drums which the MD assumes to be evenly distributed over the 300 working
days in a year. The cost of delivery is estimated at Shs. 2,500 per order and the annual
variable holding cost per drum at Shs. 4,500 plus 10% of the purchase price.
Using these data, the MD calculated the EOQ and proposes that it should be used as the
basis for future purchasing decisions of the industrial chemical.
The Purchasing Manager‟s view:
Provided in the employment contract of the company‟s purchasing manager (PM), is a
clause stating that he will receive a bonus (rounded at the nearest Shs. 100) calculate as follows:
b = [1,000,000 – (OC + HC)] x 0.1
where: b is the annual bonus.
OC is the annual ordering cost.
HC is the annual holding cost.
Using the same assumption as the MD, the PM points out that in making his calculation, the
MD has not only ignored the bonus but also the fact that suppliers offer quantity discounts
on purchase orders, where if the order size is 200 drums or above, the price per drum for an
entire consignment is only Shs. 4,990 compared to Shs. 5,000 when the order is between 100
and 199 drums and Shs. 5,010 when an order is between 50 and 99 drums.
The Finance Director's view:
The company's finance director (FD) accepts the need to consider quantity
discounts and pay a bonus, but he also holds the view that the MD‟s approach is too
simplistic. He points out that there is a three days lead time for an order and that demand has
not been entirely even over the past year. Moreover, if the company has no drums of the
chemical in stock, it will lose specific orders as potential customers will source the chemical from
competitors. He gives the frequency of lead time demand over the last year as follows:
fig1475906.png
Under the circumstances, the MD decided that he would seek further advice on the
course of action to be taken by the company.
Required:
(a) The EOQ as originally determined by the company‟s managing director.
(b) Determine the optimum order quantity, taking into consideration the MD‟s
assumptions and after allowing for the purchasing manager‟s bonus and
supplier quantity discount.
(c) The safety stock the company should maintain after applying the finance director‟s
assumptions and assuming further that the supplier‟s contract requires
that the order quantity be constant for all the orders in a year.
(d) As a consultant, write a brief report to the managing director on the
company‟s stock ordering and stock holding policies, referring where necessary to
your answers in (a) to (c) above. The report should refer to other factors that should be
considered when making the final decisions on stock ordering and holding policies.

  

Answers


Kavungya
fig1575907.png
fig1675908.png
Kavungya answered the question on May 7, 2021 at 06:08


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