A high volume paper manufacturer borrows $1M to purchase a new printing machine.

Question

A high volume paper manufacturer borrows $1M to purchase a new printing machine. The annual debt payment is $150,000. The machine can make different types of paper but the machine must be shut down for one day each time it switches production to another type of paper. The manufacturer spends about 24 days per year due to produce changeovers. The annual debt payment over those 24 days yields $6250 per day. Should the company use this cost, $6250, as an input to the EOQ model to determine optimal batch sizes for each type of paper? Choose the best answer/explanation.

Yes, $6250 is incurred per day independent of the subsequent production volume, so it is the setup cost in the EOQ model.

Yes, $6250 is incurred per day independent of the subsequent production volume, so it is the holding cost in the EOQ model.

No, the square root of $6250 should be input into the EOQ model as the setup cost.

None of them is correct.

Yes, $6250 is incurred per day independent of the subsequent production volume, so it is the setup cost in the EOQ model.

Yes, $6250 is incurred per day independent of the subsequent production volume, so it is the holding cost in the EOQ model.

No, the square root of $6250 should be input into the EOQ model as the setup cost.

None of them is correct.

Explanation / Answer

Option (D) - Sunk cost is not relevasnt for decision making and it cannot be recovered back.The annnual debt payment is a sunk cost therefore, it should not be used to determine the batch sizes.Option (C) is incorrect because of the wrong explaination.

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