Ralph Menard is the owner of a truck repair shop. He uses an EOQ model for each of his truck parts. He initially predicts the annual demand for heavy-duty tires to be 2,000. Each tire has a purchase price of $60. The incremental ordering costs per purchase order are $48. The incremental carrying costs per year are $4.80 per unit plus 10% of the supplier’s purchase price.
REQUIRED
1. Calculate the EOQ for heavy-duty tires, along with the sum of annual relevant ordering costs and carrying costs.
2. Suppose Menard is correct in all his predictions except the purchase price. (He ignored a new law that abolished tariff duties on imported heavy-duty tires, which led to lower prices from foreign competitors.) If he had been a faultless predictor, he would have fore- seen that the purchase price would drop to $36 at the beginning of the year and would be unchanged throughout the year. What is the cost of the prediction error?