Question

Q2. A company purchases 25,000 litres of material each year from a single supplier. At the moment, the company obtains the material in batch sizes of 800litres. The materials costs $16 per litre. The cost of ordering new batch is $32 and the cost of holding one litre in stock is $4 a year plus an interest cost equal to 15% of the purchase price of the material.
Calculate:
a. The Economic Order Quantity
b. Total ordering cost
c. Total stockholding cost
d. Total inventory cost
e. Show the Annual Savings which will be obtained if this order quantity replaced the current order size.

Answer 1

a.

Economic order quantity (EOQ) is an order size that company must adopt to minimize its total costs of inventory which includes holding cost and carrying cost. EOQ value is calculated by equating holding cost and ordering cost. EOQ is given by

EOQ =

where D is the demand for item per year,

K is the cost of ordering,

and H is holding cost per year.

Demand per year (D) = 25,000 Litres per year

K = $ 32 per order

H = 4+ (Cost of item * Holding cost %)= 4 + 15% * 16 = 4 + 2.4 =  $ 6.4 per unit per year

EOQ = = 500 litres

b.

No. of orders per year = Demand per year/ EOQ = 25,000/500 = 50

Total ordering cost = No. of orders per year * Cost per order = 50* 32= $ 1600

c.

Total carrying cost = Average inventory * cost of carrying per litre per annum

Total carrying cost = (EOQ* cost of carrying per litre per annum) /2

Total carrying cost = 500*6.4/2 = $ 1600

d. Total inventory cost = Carrying cost + Ordering cost + Purchase cost = 1600 + 1600 + 25000*16 = 403200

e.

Ordering Cost for current order size = Demand per year/ 800 = 25,000/800 = 31.25

Total ordering cost for current order size = No. of orders per year * Cost per order = 32* 31.25= $ 1000

Total carrying cost for current order size = Average inventory * cost of carrying per litre per annum

Total carrying cost for current order size = (800* cost of carrying per litre per annum) /2

Total carrying cost = 800*6.4/2 = $ 2560

Total inventory cost for current order size= Carrying cost + Ordering cost + Purchase cost = 2560 + 1000 + 25000*16 = 403560

Annual Savings = Total inventory Cost for current order size - Total inventory Cost for EOQ

Annual Savings = 403560 - 403200 = $360