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An entity sells 1,500 units of a particular item each year and orders the items in equal quantities of 500 units at a price of US $5 per unit. No safety stocks are held. If the entity has a cost of capital of 12%, its annual opportunity cost of carrying inventory is:
A. US$300
B. US$900
C. US$180
D. US$150
Answer: D
Explanation:
The annual opportunity cost of carrying inventory equals the average inventory level, times the per-unit purchase price, times the cost of capital. The average inventory level is the order quantity divided by 2. Thus, the annual opportunity cost of carrying inventory is US $150 [(500 units -2) x $ 5x .12].
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