Question

Consider the calculation of an EOQ at a manufacturer of automobile dashboard that uses a certain hinge, which costs $8.50 per hinge. The forecast is for 1,500,000 annually, spread evenly across the year. The forecast CV is of 15%. The annual holding cost rate used is 35% and the ordering cost is estimated to be $120. The lead time from order to receipt is 5 weeks. The desired service level is 90%.

a. Calculate the optimal economic order quantity (EOQ).

b. Calculate the reorder point (ROP).

Answer 1

Annual demand: 1500000 units

Costs per hinge: $8.50

Total value of annual demand: $12750000

Annual holding cost: 35% of $12750000 = $4462500

Holding cost per unit: $4462500 / 1500000 = $2.975

Ordering cost is $120 per order

Lead time is 5 weeks

Economic Order Quantity (EOQ): square root of 2FD / C

Where, F = Marginal cost per order

D = Total inventory units demanded

C = Carrying or Holding cost per inventory unit

Therefore, EOQ: Square root of 2 x $120 x 1500000 / $2.975

→ Square root of 121008403.36

→ 11000 units

Reorder point (ROP) = UL + Safety/Buffer Stock

Where, U = usage rate or demand per unit of time

L = Lead time

1500000 units required over say 48 weeks hence per week requirement is (1500000 / 48) = 31250 units

Buffer stock: 15% of 1500000 = 225000

Hence, ROP = (31250 x 5) + 225000 = 381250 units