Question

Sharon Ltd has in the past ordered raw material T in quantities of 3,000 units which is half a year’s supply. Management has instructed you, an inventory cost consultant, to advise them as to the most desired order quantities. The factory closes for 4 weeks annual leave per annum.

You are given the following data:

Inventory usage rate: 125 per week, Lead time: 3 weeks

Unit price: $1.50, Annual requirement: 6,000 units

Order cost: $9.00 per order, Carrying cost: $0.30 per unit per year Required:

Calculate the economic order quantity.

Calculate the reorder point.

How much would the company save by using this new method? (Assume the order point calculated in part b is used)

Solution:

For Requirement (a) formula is already provided in lecture slide.

For Requirement (b): Re-Order point = Lead time usage (No of weeks * Usage per week) For Requirement (c): Savings per year by ordering at EOQ (= Existing policy – EOQ policy) Existing policy = Cost of ordering + Cost of holding + safety stock

Cost of ordering = No of orders per annum * Cost of an order

Cost of holding = Average Inventory * Carrying cost per unit per annum Safety Stock = Usage per week * Lead Time * Carrying cost

EOQ policy = Cost of ordering + Cost of holding + Safety stock

For Requirement (c): Savings per year by ordering at EOQ (= Existing policy – EOQ policy)

Answer 1

Ans: )

A.) Economic order quantity = square root of [(2 x Annual demand x ordering costs) ÷ carrying costs]

= square root of [(2 x (48 x 125) x 9) ÷ 0.3]

= square root of [32,400]

= 180 Units

B.) Re-Order point = Lead time usage (No of weeks * Usage per week)

= 3 weeks x 125 units

= 375 Units

C.) Cost Comparison

		Existing Policy	New Policy
Order Size		3,000 Units	180 Units
No. of Orders	= (48 x 125) ÷ order Size	3,000 Units	180 Units
Ordering Cost	= No of orders * Cost of an order	$ 18	$ 306
Holding Cost	= Avg. Inventory * Carrying cost per unit	$ 450	$ 27
Total Cost		$ 468	$ 333

Total Cost Savings by EOQ (New method) = 468 – 333 =$ 135