Question

A large scale pharmaceutical manufacturing company estimates, based on a shipping fee of $1000 per order, that they can optimally balance inventory holding costs and shipping costs for one of their frequently used chemicals if they receive shipments of this chemical at an average rate of 4.5 times per year. The annual demand is 6500 tons. Suppose that they wish to instead receive shipments every month in order to reduce the working capital requirements of holding inventory.

(a) What shipping fee should they negotiate with the supplier?
(b) Based on this new shipping fee, what would be the reduction in annual holding cost as compared to their prior situation? Assume that they operate optimally.

Answer 1

a. The shipping fee that they should negotiate with the supplier is:

= $375 per shipment

b. Based on this new shipping fee, the reduction in annual holding cost will be 37.5%

Step-by-step explanation:

a) Data and Calculations:

Shipping fee per order = $1,000

Average shipments received per year = 4.5 times

Total shipping fee per year = $4,500 (4.5 * $1,000)

Annual demand = 6,500 tons

If shipment is changed to 12 times per year, the shipping fee that they should negotiate with the supplier = $4,500/12 = $375 per shipment

Holding cost will reduce by 37.5% (4.5/12 * 100)