Question

The current policy is to order 100,000 units when the inventory level falls to 35,000 units. However, forecast demand to meet market requirements for next year is 625,000 units. The cost of placing and processing an order is R250, while the annual cost of holding a unit in stores is 5% of the unit purchase price. Both costs are expected to be constant during the next year. Shop n Pay sells a unit of the product for R15.00 at cost plus 50%. Orders are received two weeks after being placed with the supplier. You should assume a 350-day year and that demand is constant throughout the year.

Question

1. Determine the savings that could be made should Shop n Pay switch to using the economic order quantity model.

Answer 1

Cost of item = 15/1.5 =10

ordering cost =250

Annua; demand =625000

EOQ = [ 2x annual demand x cost of ordering / cost of holding one unit per year]^0.5

= [ 2 x 625000x250 /10*0.05]^0.5

= 25000

Reorder point = demand during lead time + safety stock

35000 = (625000/350) x 14 + safety stock

35000= 25000+safety stock

safety stock=10000

Current ordering policy = 100000 units.

ordering cost = 250* (625000/100000) =1562.5

holding cost of inventory = 100000/2 x 10x0.05 =25000

holding cost of safety stock = 10000x0.05x10 =5000

Total cost with this policy = 31562.5

EOQ policy

ordering cost = 250x (625000/25000) =6250

holding cost of inventory = 25000/2 x 10x0.05 = 6250

Holding cost of safety stock =10000x0.05 x10 =5000

Total cost = 17500

Cost saving = 31562.5-17500 = 14062.5

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