Chapter 20, Problem 20.25E

Sensitivity of EOQ to changes in relevant ordering and carrying costs, cost of prediction error. Alpha Company’s annual demand for its only product. XT-590, is 10,000 units. Alpha is currently analyzing possible combinations of relevant carrying cost per unit per year and relevant ordering cost per purchase order, depending on the company’s choice of supplier and average levels of inventory. This table presents three possible combinations of carrying and ordering costs.

Relevant Carrying Cost per Unit per Year	Relevant Ordering Cost per Purchase Order
$10	$400
$20	$200
$40	$100

1. 1. For each of the relevant ordering and carrying-cost alternatives, determine (a) EOQ and (b) annual relevant total costs.

Required

1. 2. How does your answer to requirement 1 give insight into the impact of changes in relevant ordering and carrying costs on EOQ and annual relevant total costs? Explain briefly.
2. 3. Suppose the relevant carrying cost per unit per year was $20 and the relevant ordering cost per purchase order was $200. Suppose further that Alpha calculates EOQ after incorrectly estimating relevant carrying cost per unit per year to be $10 and relevant ordering cost per purchase order to be $400. Calculate the actual annual relevant total costs of Alpha’s EOQ decision. Compare this cost to the annual relevant total costs that Alpha would have incurred if it had correctly estimated the relevant carrying cost per unit per year of $20 and the relevant ordering cost per purchase order of $200 that you have already calculated in requirement 1. Calculate and comment on the cost of the prediction error.