(No. of drums) 106 104 102 100 98 96 94 4 10 16 40 14 14 2 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. (2 marks) (b) (c) 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. (4 marks) 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. (6 marks) (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. (8 marks) (Total: 20 marks) 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 + Ho)] x 0.1 where:b is the annual bonus. O is the annual ordering cost. He 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: Demand during lead Frequency time Variable Coefficient Standard t-value error Constant 309.19 96.05 3.22 Distance covered in kilometers 0.054 0.014 3.86 0.61, Durbin - Watson 1.61 statistic Regression equation II Maintenance costs = a + bd Variable Coefficient Standard t error value Constant 531.55 46.95 11.32 Distance covered in kilometers -0.031 0.007 -4.43 20.68, Durbin Watson 1.72 statistic Regression equation III Total transportation costs = a + bd Variables Coefficient Standard t-value error Constant 840.73 80.25 10.48 Distance covered in kilometers 0.023 0.011 2.09 0.29, Durbin - Watson 2.34 statistic Required: (a) Evaluate the three linear regression equations using: Economic plausibility. (ii) Goodness of fit (iii) Significance of independent variables. Specifications analysis criteria (iv) (Use a 95% confidence level where applicable). (3 marks) (3 marks) (3 marks) (3 marks) (b) List three variables, other than distance covered, that could be important drivers of the company's operating costs. marks) (3 (c) Suggest an alternative database that Wahome could have used to examine the drivers of the company's maintenance costs. (2 marks) (d) Explain three limitations of the linear regression analysis used by the company. (3 marks) (Total: 20 marks) NUMBER TWO Luka 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: NUMBER ONE Boni Wahome, a financial analyst at Green City Bus Company Ltd. is examining the behavior of the company's monthly transportation costs for budgeting purposes. The transportation costs are a sum of a two types of costs: 1) Operating costs, such as fuel and labour. 2) Maintenance costs, such as overhaul of engines and spraying. Wahome collects monthly data on items 1 and 2 above and the distance covered by the buses. Monthly observations for the year ended 31 December 2004 were as follows: Month Operating costs Maintenance Distance costs covered in kilometers (d) Shs. '000' Shs. '000' Shs. '000' January 471 437 3,420 February 504 388 5,310 March 609 343 5,410 April 690 347 8,440 May 742 294 9,320 June 774 211 8,910 July 784 176 8,870 August 986 210 10,980 September 895 280 4,980 October 651 394 5,220 November 481 381 4,480 December 386 514 2,980 Wahome ran three linear regression equations based on the data above and came up with the following results: Regression equation I Operating costs a + bd