Question

Question 3

The purchasing manager Jack Cruise, who is also Mrs Watson nephew, has a very relaxed approach to purchasing ingredients. Jack places orders every week for the same amount of ingredients. He finds that this way if he doesn’t turn up to work there will still be a plentiful supply of raw materials. Jill has just started as Jack’s assistant and believes that ordering could be done more efficiently. She has devised the following table to prove her point:

	Scenario
	1	2	3	4	5
Annual Demand	234,000	234,000	234,000	234,000	234,000
Cost per purchase order	$81.00	$81.00	$81.00	$81.00	$81.00
Carrying cost per package per year	$11.70	$11.70	$11.70	$11.70	$11.70
Quantity per purchase order	900	1,500	1,800	2,100	2,700
Number of purchase orders per year
Annual ordering costs
Annual carrying costs
Total annual inventory costs

Required:

1. Using Excel, complete the table. What is the economic order quantity (EOQ)? Comment on your results?
2. Prepare a graphical analysis of the EOQ decision.
3. STPL is about to introduce a Web-based ordering system for its customers that Jill estimates will reduce STPL’s ordering costs to $49 per purchase order. Calculate the new EOQ and the new annual ordering and carrying costs.
4. Prepare a graphical analysis of the new EOQ decision and comment on the differences.

Answer 1

Economic Order Quantity is the level of inventory that minimizes the total inventory holding costs and ordering costs. It is one of the oldest classical production scheduling models. Economic order quantity refers to that number (quantity) ordered in a single purchase so that the accumulated costs of ordering and carrying costs are at the minimum level. In other words, the quantity that is ordered at one time should be so, which will minimize the total of. Cost of placing orders and receiving the goods, and Cost of storing the goods as well as interest on the capital invested.

The economic order quantity can be determined by the following simple formula:

Formula

economic order quantity (EOQ) formula

EOQ= √ 2*RU*OC

UC*CC%

EOQ = Economic Order Quantity,

RU = Annual Required Units,

OC = Ordering Cost for one Unit

UC = Inventory Unit Cost,

CC = Carrying Cost as %age of Unit Cost