CAF-5 · Chapter 16
Inventory Management MCQs with Answers
10 multiple-choice questions on Inventory Management for CAF-5 Management Accounting. Try each one before revealing the answer and explanation.
Practise this chapter interactivelyQuestion 1
What is the primary objective of using the Economic Order Quantity (EOQ) model in inventory management?
- A) To maximize the total quantity of inventory held in the warehouse.
- B) To calculate the exact safety stock required to eliminate all stock-outs.
- C) To minimize the sum of total annual holding costs and total annual ordering costs.
- D) To minimize the purchase price per unit of raw material.
Show answer & explanation
Answer: C) To minimize the sum of total annual holding costs and total annual ordering costs.
The fundamental principle of the EOQ model is to find the perfect balance (the optimal order size) where the total annual costs of placing orders and the total annual costs of holding the inventory are minimized.
Question 2
Which of the following costs is typically classified as an inventory "holding cost" (or carrying cost)?
- A) The administrative cost of processing a supplier's invoice.
- B) The delivery and transportation costs of receiving goods from a supplier.
- C) The opportunity cost of capital tied up in the inventory.
- D) The cost of lost sales due to a stock-out.
Show answer & explanation
Answer: C) The opportunity cost of capital tied up in the inventory.
Holding costs (or carrying costs) include expenses associated with storing inventory, such as warehouse rent, insurance, deterioration, and importantly, the opportunity cost (financing cost or interest) of the capital that is tied up in the stock.
Question 3
Replica Limited has an annual demand of 162,000 units for a specialized component. The cost of placing one order is Rs. 27,000, and the annual holding cost per unit is Rs. 300. What is the Economic Order Quantity (EOQ) for this component?
- A) 2,700 units
- B) 5,400 units
- C) 10,800 units
- D) 300 units
Show answer & explanation
Answer: B) 5,400 units
The EOQ formula is: sqrt((2 * Co * D) / Ch). In this case: sqrt((2 * 27,000 * 162,000) / 300) = sqrt(8,748,000,000 / 300) = sqrt(29,160,000) = 5,400 units.
Question 4
Saturn Limited imports raw materials with the following usage and lead time parameters: Maximum usage is 5,000 units per month, minimum usage is 3,000 units per month, maximum lead time is 4 months, and minimum lead time is 2 months. Using the standard formula, what should be the Re-order Level (ROL) for this raw material?
- A) 11,250 units
- B) 20,000 units
- C) 15,000 units
- D) 8,000 units
Show answer & explanation
Answer: B) 20,000 units
The standard formula for establishing a Re-order Level to prevent stock-outs under maximum expected conditions is: Maximum Usage × Maximum Lead Time. Calculation: 5,000 units × 4 months = 20,000 units.
Question 5
Why do manufacturing companies maintain a "Safety Stock" (buffer stock)?
- A) To increase the total number of orders placed in a year.
- B) To protect the business against stock-outs caused by unpredictable fluctuations in demand or delays in lead time.
- C) To take advantage of bulk purchase discounts offered by suppliers.
- D) To reduce the total holding costs of the warehouse.
Show answer & explanation
Answer: B) To protect the business against stock-outs caused by unpredictable fluctuations in demand or delays in lead time.
Safety stock acts as a buffer. If demand during the lead time is higher than average, or if the supplier takes longer than average to deliver, the safety stock ensures production does not halt.
Question 6
If a company's average weekly demand for a component is 90 units, the expected lead time is 2 weeks, and management has decided to maintain a safety stock of 50 units, what is the appropriate Re-order Level?
- A) 180 units
- B) 230 units
- C) 140 units
- D) 90 units
Show answer & explanation
Answer: B) 230 units
When a safety stock is maintained, the Re-order Level is calculated as: (Average Demand × Average Lead Time) + Safety Stock. Calculation: (90 units × 2 weeks) + 50 units = 180 + 50 = 230 units.
Question 7
When evaluating whether to accept a bulk purchase discount from a supplier, which of the following financial trade-offs must be assessed?
- A) The decrease in total holding costs against the increase in total ordering costs.
- B) The savings in purchase price and ordering costs against the increase in total holding costs.
- C) The reduction in safety stock against the increase in the cost per unit.
- D) The increase in stock-out costs against the decrease in holding costs.
Show answer & explanation
Answer: B) The savings in purchase price and ordering costs against the increase in total holding costs.
Buying in bulk reduces the unit purchase price and decreases the number of orders placed per year (saving ordering costs). However, because larger quantities arrive at once, the average inventory increases, which drives up holding costs. The decision relies on calculating if the savings outweigh the extra holding costs.
Question 8
If a company uses the Economic Order Quantity (EOQ) model and also maintains a permanent safety stock, how is the "average inventory level" calculated for the year?
- A) (EOQ ÷ 2) + Safety Stock
- B) EOQ + Safety Stock
- C) (Maximum Inventory Level + Minimum Inventory Level) ÷ 2
- D) Re-order Level - Safety Stock
Show answer & explanation
Answer: A) (EOQ ÷ 2) + Safety Stock
Under the EOQ model, average cycle inventory is half of the order quantity (EOQ/2). If a company also holds a permanent safety stock, this baseline amount is added to the average cycle stock to find the total average inventory level throughout the year.
Question 9
Which of the following is an example of an "ordering cost" in inventory management?
- A) Insurance premiums paid on the warehouse contents.
- B) Clerical and administrative costs of preparing and issuing a purchase order.
- C) Deterioration and obsolescence of stored raw materials.
- D) Variable overheads incurred during production.
Show answer & explanation
Answer: B) Clerical and administrative costs of preparing and issuing a purchase order.
Ordering costs are the costs incurred every time an order is placed. This includes administrative costs, phone calls, documentation, expediting, and goods receiving/inspection costs.
Question 10
Which of the following is a practical limitation or underlying assumption of the basic Economic Order Quantity (EOQ) model?
- A) It assumes that the purchase price per unit remains constant regardless of the order size.
- B) It assumes that customer demand is highly seasonal and unpredictable.
- C) It assumes that lead times fluctuate wildly from order to order.
- D) It assumes that holding costs decrease proportionately as inventory levels rise.
Show answer & explanation
Answer: A) It assumes that the purchase price per unit remains constant regardless of the order size.
The basic EOQ model relies on several rigid assumptions to work smoothly: demand is known and constant, lead time is known and constant, and the purchase price per unit does not change (i.e., it ignores bulk discounts).