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): ReOrder 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)
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.) ReOrder 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
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