Relevant and Irrelevant Costs of Carrying A firm is introducing an inventorycontrol system designed to minimize inventory costs, subject to required customer service levels that are influenced, but not completely determined, by shortage-cost estimates. A large range of products is carried, but for the purposes of this preliminary study, ‘the following item may be taken as “average”

with regard to selling price and cost structure. However, this is not necessarily a high-volume item.

CURRENT DATA FOR ONE (AVERAGE) UNIT Selling price $20 Purchase-invoice cost 10 Road freight inward 1 Air freight inward 20 BUDGETS AND ESTIMATES (OTHER THAN DATA ABOVE)

Annual sales $1.5 million Advertising budget 5% of sales budget Administration $100,000 per year Property costs (depreciation, etc.) $50,000 per year Interest and insurance on inventory 30% per year Warehouse operating cost $2,000 per week + $10 per incoming order (bought) + $1 per unit sold.

(Note: The warehouse has spare capacity.)

Clerical and other office costs $1,000 per week + $2 per purchase order processed + $1 per unit sold. (Note: Buying lead time is about 2 weeks by road and 1 day by air freight.)

Estimate unit carrying and shortage (stockout) costs, and the relevant cost of a purchase order. State the assumptions necessary to support your conclusions;

there may be more than one answer in some Cases. lop5