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ANNUAL TRANSPORTATION AND IN-TRANSIT INVENTORY COSTS

ANNUAL TRANSPORTATION AND IN-TRANSIT INVENTORY COSTS. Calculating Annual Transportation Cost. Volume transportation rates: reduced rate applies to the entire shipment Annual transportation cost = (freight rate per unit) x (annual demand in units) F = freight rate per unit

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ANNUAL TRANSPORTATION AND IN-TRANSIT INVENTORY COSTS

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  1. ANNUAL TRANSPORTATIONAND IN-TRANSIT INVENTORY COSTS

  2. Calculating Annual Transportation Cost • Volume transportation rates: reduced rate applies to the entire shipment • Annual transportation cost = (freight rate per unit) x (annual demand in units) • F = freight rate per unit • FD = annual transportation cost

  3. Many carriers (notably LTL motor carriers and railroads) quote transportation rates in $ per hundred pounds, or $ per cwt • Convert units to cwts or freight rate per cwt to freight rate per unit; we will convert the freight rate • Divide the freight rate per cwt by the number of units in a cwt; number of units in a cwt is 100/unit weight in pounds Example: freight rate per cwt = $30; weight per unit = 15 pounds; freight rate per unit = $30/(100/15) = $4.50 per cwt

  4. Calculating the Annual In-transit Inventory Cost • Annual in-transit inventory cost = (annual in-transit inventory level in units) x (average value per unit of inventory) x (the cost of carrying in-transit inventory expressed as a percentage of investment in in-transit inventory)

  5. Two new variables: • I = opportunity cost of capital = cost of carrying in-transit inventory (%) • T = average transit time (in days)

  6. Annual in-transit inventory level = (Q units in in-transit inventory each shipment) x (number of days in transit as percentage of a year, or T/365) x (number of shipments per year, or D/Q) = (Q) x (T/365) x (D/Q) = DT/365

  7. Average value of inventory per unit = V • Cost of carrying in-transit inventory = I • Thus, annual in-transit inventory cost = DTVI/365

  8. New and improved annual T.L.C.: .5QVC + PD/Q + FD +DTVI/365 Note: taking derivative, setting equal to zero, and solving for Q results in EOQ equation (because ‘Q’ does not show up in annual transportation cost and annual in-transit inventory cost expressions) • Thus, we need to compare T.L.C. at EOQ volume and at Q values greater than EOQ volume where transportation freight rate discounts are offered.

  9. Total cost Annual cost (dollars) L o w e s t t o t a l c o s t ( E O Q ) Inventory carrying cost Ordering cost Size of order Transport cost In-transit inv. cost QT EOQ

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