Economic Order Quantity

Topics: Economic order quantity, Marginal cost, Cost, Inventory, Variable cost, Costs / Pages: 10 (2415 words) / Published: Jun 12th, 2013
Worked Examples for Chapter 18

Example for Section 18.3

Computronics is a manufacturer of calculators, currently producing 200 per week. One component for every calculator is a liquid crystal display (LCD), which the company purchases from Displays, Inc. (DI) for $1 per LCD. Computronics management wants to avoid any shortage of LCDs, since this would disrupt production, so DI guarantees a delivery time of 1/2 week on each order. The placement of each order is estimated to require 1 hour of clerical time, with a direct cost of $15 per hour plus overhead costs of another $5 per hour. A rough estimate has been made that the annual cost of capital tied up in Computronics’ inventory is 15 percent of the value (measured by purchase cost) of the inventory. Other costs associated with storing and protecting the LCDs in inventory amount to 5 cents per LCD per year.

(a) What should the order quantity and reorder point be for the LCDs? What is the corresponding total variable inventory cost per year (holding costs plus administrative costs for placing orders)?

We calculate the data needed for the basic EOQ model as follows:

Demand per year for LCD = 52(200/week) = 10,400/year.

Setup cost = direct cost + overhead cost = ($15/hr)(1 hr) + ($5/hr)(1 hr) = $15 + $5 = $20.

Unit holding cost = 15% of the value of each LCD + 5 cents of storing and protecting cost per LCD = 15%($1) + $0.05 = $0.20 per LCD.

Delivery time = 1/2week = 3.5 days.

Working days per year = 365 days/year.

We use the Excel template for the basic EOQ Model (shown next) and obtain the following solutions:

Optimal order quantity = 1442.

Reorder point = 99.7.

Total variable inventory cost per year = $288.44.

(b) Suppose the true annual cost of capital tied up in Computronics’ inventory actually is 10 percent of the value of the inventory. Then what should the order quantity be? What is

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