The total cost of the safety stock is the carrying cost plus the expected stockout cost. If the company carries 100 units of safety stock, the cost of carrying the safety stock will be $1,000 for the year. This is calculated as 20% of the value of the safety stock. The average inventory investment per unit is $50. For 100 units, the carrying cost is $50 × 100 × .20, or $1,000. The stockout cost is $5 per unit. At a safety stock level of 100 units, if a stockout occurs, the number of units the company would be short would be 100 units (from the "Stockout" column). Therefore, the cost of one stockout would be 100 × $5, or $500. The company orders inventory an average of 10 times per year. The probability of a stockout occurring at a safety stock level of 100 units is 15%. Therefore, during a year's time, the expected number of stockouts is 10 × .15, or 1.5 times. At a cost of $500 per stockout, this is an expected annual cost of $750 ($500 × 1.5). Since the total cost of the safety stock is the carrying cost plus the expected stockout cost, the total cost of the safety stock on an annual basis with a safety stock level of 100 units is $1,000 carrying costs plus $750 stockout costs, or $1,750.
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This answer can result from totalling the amounts in the "Stockout" column and multiplying the total by the stockout cost of $5 per unit. The amount of the stockout to use is only the amount at the level of the number of units of safety stock held. Furthermore, this answer does not take into consideration the carrying cost of the safety stock.
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The total cost of safety stock on an annual basis with a safety stock level of 100 units is