119

INVENTORY CONTROL
The Purpose and Importance of Inventories
Inventory is a traditional topic in P/O Management. The basic objective of
inventory management has traditionally been to keep inventory at desired level that
will meet product demand and also be cost effective. Whether a company buys parts
and products or produces them, it is faced with decisions about inventory.
Inventory can be defined as a stock of materials created to satisfy some
eventual demand.
Inventories are idle resources of any kind that possesses economic value and
held for future use.
Inventories are present whenever the inputs and outputs of a company are not
used as soon as they become available. In general, most people think of inventory as a
final product waiting to be sold to a retail customer. e.g. a new car, a can of ananas at a
grocery store. This is of course one of its most important uses. Inventory can take on a
number of different forms besides finished goods, such as raw materials, supplies, parts
etc. Inventory can be viewed as a necessary evil. Although it costs money to hold,
inventory helps with the customer service and resource utilisation and reduces
ordering, set up, transportation and purchased material costs. One of the major
functions of materials management is to uncouple activities, providing some degree of
independence at various points in materials flow system. In other words, the
inventorys primary purpose is to see that the right amounts of input materials are
available for the production process when they are needed. In order to do this, a firm
must ordinarily stock, or inventory, the input materials. The question is: How much
inventory should be held? If there is too little, the production process may stop,
because of lack of raw materials. On the other hand, management doesnt want to
carry too many inventories; surplus inventories are often termed the graveyard of
business and thought to be one of the principal causes of business failure. The
importance of avoiding surplus inventories is partially due to the increasing risk of
obsolescence. Unnecessarily large inventories can introduce inflexibility and rigidity
into a firms operations; the unavailability of these funds may necessitate missed
investment opportunities and possibly serious losses.
The major goal of any inventory control system is to discover and maintain the
best possible level of inventory in terms of both units of product and least possible
cost. As stated above, in reaching this goal management seeks to avoid two common
pitfalls:
i. Management tries to avoid the problem inadequate levels of inventory since
too little inventory disrupts production and may result in lost sales.
ii. The existence of too many inventories increases the risk of obsolescence and
creates unnecessary cost levels, both of which are the utmost concern to
management.
The best possible level of inventory is located somewhere between these two
extremes.

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Inventories are vitally important to manufacturing firms. Service operations and

job shops tend to have small investment in inventory. Large manufacturing firms may
have 100 000 or more different items to maintain in inventory or control. This number
alone is large, but when it is multiplied by the number of units of each item on hand,
the number of units and the investment in inventory of such a firm are tremendous.
Inventories are neither totally good nor totally bad. Adequate inventories
facilitate production activities and help to assure customers of good service. In any
organization, inventories add an operating flexibility that would not otherwise exists. In
manufacturing, work-in-process inventories are an absolute necessity. Patients in a
hospital are really inventory for the physician, true they are there because they are too
sick to be at home, but it must be recognized that having them in one location enables
the physician to see all his patients during "rounds". On the other hand, holding
inventories ties up working capital on goods that sit idle, i.e. not earning any return on
investment. The fundamental reason for carrying/holding inventories that "it is
physically impossible and economically impractical for each stock item to arrive
exactly where it needed exactly when it is needed". The following summarise the
major points for holding inventories:
i.
ii.
iii.
iv.
v.
vi.
vii.

Service customers with variable (immediate and seasonal) demands,

Protect against supply errors, shortages and stock-outs,
Help level production activities, stabilize employment and improve
labour relations,
Decouple successive stages in operations so breakdowns do not stop
the entire system.
Facilitate the production of different products on the same facilities,
Provide a means of obtaining and handling materials in Economic Lot
Sizes and of gaining quantity discounts.
Provide a means of hedging against future price and delivery
uncertainties such as sticks price increases and inflation.

.
Inventory Control is the technique of maintaining stock keeping items at
desired levels.
Inventories that are to be held might not all be managed in the same way.
Selection of any inventory control method depends on number of things:
i.
ii.
iii.
iv.

The length of time the firm intends to maintain the inventory,

The type of demand it is to serve,
The cost of the item,
The degree of control desired
and so on.

The basic inventory problem confronting management is that of minimising the

total cost of inventory while maximising customer satisfaction. Fortunately, as we shall
see, this problem can be solved through the use of some very practical formulas.
Operationally, such an approach provides a basis for answering four controlrelated questions:

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1. Should an order be placed?

2. If an order is to be placed, how large should the order be?
3. If an order is to be placed, should it be expedited?
4. Do the market and/or production conditions justify a deviation from the
normal inventory policy?
To provide management with reasonable responses to the preceding questions,
the initial model is generally modified to reflect operational situations. These modified
models are then used as a basis for answering three principal questions; which
constitute the purpose of inventory management:
1. When should an order be placed?
2. How much should be ordered?
3. What is the cost of inventory policy that has been selected?
Given the answers to these three questions, management can then address itself
to the problems of expediting an order and of policy deviation.
Single-Period and Multiple Period-Inventories
Single-period inventory involves items that will be stocked only once; with no
intention of restocking them they are consumed. Multiple-period inventory involves
items that will be managed to maintain in inventory long enough that units, which have
been consumed, may be replenished. The amount and timing of future replenishments
can be varied to adjust the inventory level in response to demand. Multiple-period
inventories are kept for most finished products and parts and are much more common
than single-period inventories.
Marginal Analysis for Single-Period Inventories
Consider a business that is to select the quantity of an item to buy when there is
only one period in which demand for the item can occur and the level of that demand is
not known. Assume, however, that a probability distribution for the various level of
demand that might occur is available or can be estimated. Assume also that the firm
will not be able to buy additional quantities of them, if it does not buy enough the first
time.
The single-period model is used to handle ordering of perishables (e.g. fresh
fruits, cut-flowers, vegetables) and items that have a limited useful life (e.g.
newspapers, magazines, spare parts for specialised equipment). What sets unsold or
unused goods apart is that they are not typically carried over from one period to the
next, at least without penalty. Analysis of single-period situations generally focuses on
two costs:

shortage or opportunity cost

and
overstocking or excess costs.

There are two general categories of problems that we will consider;

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those for which demand can be approximated using a continuous

distribution (perhaps a theoretical
one such as a uniform or normal
distribution
those for which demand can be approximated using a discrete distributions
( historical frequencies) .

The kind of inventory can indicate which type of model might be appropriate
e.g demand for petroleum, liquids and gases tends to vary over some continuous scale,
thus lending itself to description by a continuous distribution. Demand for tractors,
cars and computers are expressed in terms of the number of units demanded and lends
itself to description by a discrete distribution.
Discrete Stocking Levels
If a unit of the product is not sold, there will be a cost to the firm of K o for
overstocking. This is the cost of the unit minus any salvage value. The firm will suffer
an opportunity cost of Ku per unit for understocking. This amount is equal to profit per
unit. The goal is to identify the order quantity or stocking level, which will minimise as
a long run over-and under-stocking costs.
The firm should add units to the order quantity as long as the expected cost of
adding the last unit is less than the expected gain. That is, the order should be
increased as long as the expected cost of overstocking for the next unit is less than he
expected cost of under stocking for it. The objective is "to find which unit is the last
unit that the firm should add to the order."
Let
P (C) = Probability of demand where the level is greater than or equal to a
particular number of units
Then P(C) is a value from a cumulative probability distribution with a cumulating
beginning at the highest possible level of demand. That is;
P(C) Ku > [1-P(C)]Ko
The optimum order size is associated with P (C) that makes the two expected
costs equal. Let us now identify the Critical Probability that makes the two costs equal
as P(C)*;
P(C)* Ku =[1-P(C)*]Ko
P(C)* = Ko / ( Ko + Ku )

The best quantity to stock is the highest possible quantity that has a
cumulative probability of demand greater than or equal to the critical probability.
EXAMPLE 1:

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The Bazaar Department Store has an opportunity to buy a special shipment of

tableware at 28 million MU a set. These sets of tableware are to be sold for 35 million
MU as a special promotion during the new year sales. Bazaar must purchase the item
in units of a dozen sets. Tableware is not part of Bazaars normal product line, so if the
items are not sold during the new year sales, they will be sold to the rest sales firms for
22.5 million MU per set. Mr. Ali alkan , a buyer for Bazaar, has estimated the
probability for demand for the item.
DEMAND
(C)
(Dozens)

4 or less
5
6
7
8
9
10
11
12 or more

PROBABILITY OF
DEMAND

CUMULATIVE
PROBABILITY
OF
DEMAND
(Probability demand will
P(C)
equal this level)
(Probability demands will
equal or exceed this level)
0.00
1.00
0.10
1.00
0.15
0.90
0.25
0.75
0.20
0.50
0.15
0.30
0.10
0.15
0.05
0.05
0.00
0.00

Solution:
Ko = 28 MU 22.50 MU =5.50 MU

K u = 35 MU 28 MU = 7.00 MU

Then,
P (C)* = Ko / (Ko+Ku) =5.50 /(5.550+7.00) = 0.44
The largest quantity with P (C) 0.44 is 8, so it is recommended to order 8 dozen sets
of tableware.
EXAMPLE 2:
A seasonal style product must be ordered by a store several months before the
season and can be purchased at 16.25 MU per unit. The retail price for the item
will be 26.95 MU during the season. No fill-in stock can be ordered during the
season if the store runs out of stock. Any excess stock left at the end of the
season will be sold for 14.95 MU. The buyer estimates the following probability
distribution for the selling various numbers of products. Determine the number
of dozens to order that will maximise the stores expected profit.

Number that May Be Demanded

(Dozens)

Probability of This Demand

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6
7
8
9
10
11
12
13
14
15

0.03
0.05
0.07
0.15
0.20
0.20
0.15
0.07
0.05
0.03

Solution:
If the store overstocks, the loss per unit for every excess unit at the end of the
season will be;
Ko = 16.25 MU - 14.95 MU = 1.30 MU
If the store understocks, the opportunity cost for every unit the company could
sell but did not stock will be;
Ku = 26.95 MU - 16.25 MU = 10.70 MU
Then the critical probability is;
P(C)* = Ko / ( Ko + Ku) = 1.30 / ( 10.70 + 1.30) = 0.108
The level of stock that will maximise expected profit is the highest level of
stock that has a probability greater than or equal to 0.108 that will be sold. From the
table you can see that 13 is the highest level with a probability greater than 0.108.

Level that Might be Stocked

(Dozens)
6
7
8
9
10
11
12
13
14
15

Probability that Demand Will Equal or

Exceed This Level, P(C)
1.00
0.97
0.92
0.85
0.70
0.50
0.30
0.15
0.108
0.08
0.03

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EXAMPLE 3:
A distributor can purchase TV sets for 285 MU a set and sell these sets at 490
MU through regular channels. Any sets unsold at the end of the model year can be sold
to another distributor, TV max, for 215 MU. Calculate P (C)* and the distributors
recommended order quantity base on the probability distribution of demand for the TV
sets and the assumption that the distributor can only order new sets one time:
Demand (C)

Probability of Demand

8 or fewer
9
10
11
12
13
14 or more

0.00
0.27
0.34
0.19
0.12
0.08
0.00

Solution:
Ko = 285 MU - 215 MU = 70 MU
Ku = 490 MU - 285 MU = 205 MU
P(C)* = Ko / ( Ko + Ku ) = 70 / ( 70 + 205) = 0.2545

Level of Demand

Cumulative Probability, P(C )

8 or fewer
9
10
11

1.00
1.00
0.73
0.39
0.2545

12
13
14

0.20
0.08
0.00

Distributor should order 11 sets, 0.39 = 0.2545

EXAMPLE 4:
Submarine sandwiches can be prepared for 1.39 MU a sandwich and can be
sold for 3.25 a sandwich. Should the sandwiches not be bought the day they are made
they can be sold to a mission for 0.87 MU. The probability distribution of demand for

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the sandwiches is presented below. Calculate P (C)* and the number of sandwiches
that should be made each day.
Demand

Probability of Demand

24 or fewer
25
26
27
28
29
30
31 or more

0.00
0.10
0.18
0.27
0.21
0.15
0.09
0.00

Solution :
Ko = 1.39 MU - 0.87 MU = 0.52 MU,
Ku= 3.25 MU - 1.39 MU = 1.86 MU
P ( C )* = Ko / ( Ko + Ku ) = 0.52/2.38 = 0.2185

Demand

Cumulative Demand

24 or fewer
25
26
27
28
29

1.00
1.10
0.90
0.72
0.45
0.24

30
31 or more

0.09
0.00

0.2185

Therefore, P (C) P (C)* = 0.24 is 0.2185. Make 29 sandwiches each day.

EXAMPLE 5:

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Daily Sales, local retailer is confronted with the problem of determining an

optimal inventory policy. An analysis of relevant sales data has revealed the following.
Demand
20 000
21 000
22 000
23 000
24 000
25 000
TOTALS

Frequency of
Demand
10
15
20
40
10
5
100

Relative
Frequency
10/100
15/100
20/100
40/100
10/100
5/100
100/100

Relative
Probability
0.10
0.15
0.20
0.40
0.10
0.05
1.00

Determine an optimal inventory level, given that each unit sells for 100 MU and
costs 75 MU. Unsold units can be salvaged for 10 MU.
Solution :
Ko = Cost of overstocking

(Marginal loss) = 75 MU - 10 MU = 65 MU

Ku = Cost of under stocking (Marginal Profit)= 100 MU - 75 MU=25MU

P (C)* = Ko / (Ko + Ku) = 65 / ( 25+65)= 0.722

Demand
C
20 000
21 000
22 000
23 000
24 000
25 000
26 000

Relative Probability
0.10
0.15
0.20
0.40
0.10
0.05
0.00
1.00

Probability ( at least C
units demanded )
1.00
0.90
0.75
0.722
0.55
0.15
0.05
0.00

The critical ratio is 0.722. Marginal loss (cost of overstocking) is defined as the
loss that results when the kth unit is not sold; i.e it is the amount by which profits are
reduced through the failure to sell the last extra unit. There for the inventory level of
22 000 units is best (0.75 > 0.722). At 23 000 units, cumulative probability is 0.55,
which is less than the critical ratio.
EXAMPLE 6:

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Azim Manufacturing produces for stock a certain part that is used in the
custom job department. Each unit costs 5.75 MU to manufacture and is charged to
customers at 7.00 MU. The parts must be remade, with no salvage value, if they are
not used within a year. Therefore, minimising of excessive inventory is a prime
management objective a study of past usage records has revealed the following
demand pattern.
Units Required

Frequency of Occurrence

15 000
16 000
17 000
18 000
19 000
20 000
21 000

12
18
35
20
8
7
0
100

Relative
Probability
0.12
0.18
0.35
0.20
0.08
0.07
0.00
1.00

What is the optimal inventory level for this part?

Solution :
Ku = 7.00 MU - 5.75 MU = 1.25 MU
Ko = 5.75 MU - 0 MU = 5.75 MU
P(C)* = Ko / (Ko + Ku) = 5.75 / (5.75+1.25) = 0.821
Units Demanded

Relative Probability

15 000
16 000

0.12
0.18

17 000
18 000
19 000
20 000
21 000

0.35
0.20
0.08
0.07
0.00

Probability(at least C
units demanded)
1.00
0.88
0.821
0.70
0.35
0.15
0.07
0.00

The critical ratio is between 16 000 and 17 000 units. We select 16 000 units as
optimal inventory level, because it is lesser of the two levels.
Continuous Stocking Levels
Critical probability of discrete stocking level also represents the Stock-out
Risk associated with the corresponding level of stock. Stock-out risk is the
complement of the Service Level, The service level is the probability that demand
will not exceed the stocking level and computation of the service level is the key to
determining the optimal inventory level, I opt .
SL=100% - P(C)*= Ku / (Ko + Ku)

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Iopt is determined according to the distribution of demand.

a. If the demand is uniformly distributed Iopt is calculated as follows;
Iopt = Cmin + %SL ( Inventory)
Iopt is determined according to the distribution of demand.
b. If the demand is normally distributed Iopt is calculated as follows;

Iopt = + Z
Ko

Ku
Service Level

Cmin

Iopt

Quantity

Cmax

Fig.1 : The optimal stocking level balances unit understocking and overstocking costs.
EXAMPLE 7: (Single-Period model uniformly distributed)
The City Chronicle has a daily newspaper demand that varies from between 20 000
and 24 000 copies per day. The paper costs 0.08 MU per issue to produce and
generates revenue of 0.20 MU per issue. Unsold papers have no value.
a) What is the optimal level of papers to stock?
b) What service level would that optimal level corresponds with?
Solution :
Ku P (C) = K [1 - P (C)]
P (C) *= Ko / Ko + Ku
Where
Ko = Cost / unit - Salvage Value = 0.08 - 0 = 0.08 MU
Ku = Revenue / unit - Cost / unit = 0.20 - 0.08 = 0.12 MU
P(C)* = 0/08/(0.08+0.12) =0.40
The 0.40 is the equating probability that demand will be exceeded and
represents a stock out risk established on the basis of the basis of costs given.

130

Thus the corresponding service level is

SERVICE LEVEL = 1 - STOCKOUT RISK
SL = 1 - 0.4 = 0.6
I opt = Cmin + % SL ( Inventory)
Iopt = 20.000 + 0.6 (24.000 - 20.000) = 22.400 Units

EXAMPLE 8:
A magazine shop owner has four different retail locations. A popular monthly
magazine varies uniformly from 500 to 1200 copies for demand at all stores combined.
Ordering is centralised and magazines can be moved easily from store to store. The
magazine cost 125 MU/hundred and sells for 2.25 MU/each. When purchased in lots at
this price, the publisher accepts no returns. What should be the ordering quantity for
the next period?
Solution :
P (C)* = [ Ko / (Ko + Ku)]

(Critical fractile)

Ko = 1.25 - 0 = 1.25 MU
Ku = 2.25 - 1.25 = 1.00 MU
P(C)* = 1.25/(1.25+1.00)=0.56
SL = 1 - 0.56 = 0.44
I opt = C min + % SL ( Inventory) = 500 + 0.44 (1200 500) = 808
Since orders must be in lots of 100, the closest to optimal would be to order
800 copies of the magazine for next month.
EXAMPLE 9:
Sweet cider is delivered weekly to ABC 's Produce Stand. Demand varies
uniformly between 300 litres and 500 litres per week. ABC pays 0.20 MU per litre for
the cider and charges 0.80 MU per litre for it. Unsold cider has no salvage value and
cannot be carried over into the next week due to spoilage.
Find the optimal stocking level and its stock out risk for that quantity.
Solution :

131

Ko = Cost per unit - Salvage value per unit

= 0.20 - 0
= 0.20 MU / unit
Ku = Revenue per unit - Cost per unit
= 0.80 - 0.20
= 0.60 MU/ unit
SL = Ku / (Ku + Ko)
= (0.60) / (0.60 + 0.20)
= 0.75
Thus the optimal stocking level must satisfy demand 75 % of the time. For the
uniform distribution, this will be at a point equal to the minimum demand plus 75 % of
the difference between maximum and minimum levels.
I opt = Cmin + SL ( Inventory) = 300 + 0.75 (500-300) = 450 litres
The stock out risk is 1.00 - 0.75 = 0.25
EXAMPLE 10: ( Single-Period model with normally distributed demand.)
Demand for a chemical product is normally distributed with =80 tons per
week and =5 tons/week. If Ko=0.15/MU/ton and Ku=0.50 mu/ton. What is the
optimal level to stock?
Solution:
P(C)* = Ko / (Ko + Ku) = 0.15 / ( 0.50 + 0.15 ) = 0.231
Iopt = + Z
where Z s for a probability area of 0.50 - 0.23 = 0.27
Z = 0.73

I opt = 80 + 0.73 (5) = 83.65 ton

EXAMPLE 11:
ABCs stand sells a blend of cherry juice and apple cider. Demand for the blend
is approximately normal with a mean of 200 litres per week and a standard deviation of

132

10 litres per week. Ku = 0.60 MU / litre and Ko = 0.20 MU / per litre. Find the optimal
stocking level for the apple - cherry blend.
Solution:
SL = Ku /( Ku + Ko) = 0.60 / (0.60 + 0.20) = 0.75
This indicates that 75 % of the area under the normal curve must be to the left
of the stocking level. Normal Distribution Table shows that a value of Z, 0.675, will
satisfy this. Thus

Iopt =200liters+0.675(10liters)=206.75

Multiple-Period Inventory Systems

Wholesale and retail establishments and many batch and repetitive
manufacturing operations have standardised products that are sold for many sales
periods. Some job shops have repeat orders for the same or similar items, so they have
fairly stable utilisation of certain raw materials and components. Single-period analysis
is not appropriate for such situations, so other models and inventory systems have been
developed to assist in the management of these inventories. The type of demand that is
to be supplied from the inventory determines the type of inventory system that is
appropriate.
The Basic Economic Order Quantity Model (EOQ Model)
There are two basic inventory decisions managers must make as they attempt
to accomplish the functions of inventory just reviewed. These two decisions are made
for every item in the inventory.

1.
2.

How much an item to order when the inventory of that item to be

replenished,
When to replenish the inventory of that item.

The economic order quantity (EOQ) model is the oldest and the best -known
inventory model ; its origins date all the way back to the 1915. The purpose of using
the EOQ model is to find that particularly quantity to order which minimises total
inventory costs. Let us look for a moment at these costs.

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Inventory Costs:
There are two basic inventory costs;

i. Ordering Costs,
ii.
Carrying or holding Costs.
Ordering Costs are basically the cost of getting the item into the firms
inventory. Therefore ordering costs are the cost of replenishing inventory. They are
occurred each time an order is placed and are expressed Monetary Unit Cost (MU)
such as $ or TL per order. Ordering Costs start with the requisition sent to purchasing
office, include all cost of issuing to purchase order and of following it up, continue
with such steps as receiving the goods and placing them into inventory, and end with
the buying firms paying the supplier. Salaries constitute the major ordering cost,
stationary is another ordering cost.
Ordering costs generally react inversely to carrying costs. As the size of orders
increases, fewer orders are required, thus reducing ordering costs. Because we want
the incremental cost per order, we need cost estimates from the purchasing
department, from the receiving warehouse and from the accounting office covering
their operations at two different levels of operation, as shown in table below. From this
table we see that the 2000 additional orders are estimated to cost us 79.000 MU; the
incremental cost per order is 79.000 MU/2000 = 39.50 MU.
Expense
Category
Purchasing
Dept. Chief
Buyers
Assistant
Buyers
Follow-up
persons
Clerks
Typists
Supplies
Receiving
Clerks
Receiving
Supplies
Accounts
Payable
Clerks
Accounting
Supplies

At 3000 Orders Per Year

At 5000 Orders Per Year
Annual
Number
Annual
Number
Annual
Salary
Required
Cost
Required
Cost
20.000MU
1
20.000MU
1
20.000MU
12.000
10.000

3
2

36.000
20.000

5
3

60.000
30.000

9.000

9.000

18.000

9.000
8.500
--8.000

3
2
2

27.000
17.000
500
16.000

4
3
3

36.000
25.500
500
24.000

---

300

500

10.000

30.000

40.000

---

450

750

TOTAL EXPENSES
Table 1: Ordering costs.

176.250

255.25

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Carrying / Holding Costs are basically the costs incurred because a firm owns
or maintains inventories. Carrying costs are the costs of holding items in storage.
These costs vary with the level of inventory and occasionally with the length of time an
item is held; that is, the greater the level of inventory over time, the higher the carrying
costs. Carrying/Holding Costs include:

Interest on money invested in inventory,

Obsolescence. A cost incurred when inventories go out of style,
Storage space cost, which includes heat, lights, or refrigeration,
Storage operation, including record keeping, the taking of physical inventory
and protection,
Taxes, insurance and pilferage.

Carrying costs can be expressed as a percentage of average inventory value say

22% per year to hold inventory, Z or as a cost per unit per time period (say 0.25
MU per unit per month to hold inventory),E.
Using inventory-holding costs as a percentage of the product p is convenient
because, regardless of the price of the product, the same percentage can be applied. If
you calculate that it costs you 25% of the value of an item to hold it for a year, then
inventory carrying costs on a 12MU case of a floor-cleaning compound would be 0.25
1.20 or 0.30 MU per year.
Concept of Average Inventory
If a firm buys an item only once for the coming year, if use of the item is
constant, and if the last of the item is used on the last day of the year, then the firms
average inventory equals one-half of the amount bought; this is the same as saying one
-half of the beginning inventory. Fig.1 shows average inventory under conditions of
constant use.
Maximum inventory, x

Inventory
Demand
Rate,
Average Inventory, x/2
R0

tlt

Supply begins and ends (Instantaneous supply)

135

Fig.1: Average inventory order placed with order receipt constant use
The Basic Economic Order Quantity Model
Since some costs increase as inventory increases and others decrease, the
decision as to the best size of an order is seldom obvious. The best lot size will result in
adequate inventory to reduce some costs, yet will not be so large that it results
needless expenses for holding costs. The Economic Order Quantity (EOQ). Model
provides assistance in reaching a decision when the conditions are appropriate for its
use. The earliest published derivation of the basic EOQ model formula occurred in
1915 and is credited to Ford Harris, an employee at Westinghouse; EOQ is the
optimal order quantity that will minimise total inventory costs. There are several
variations of the EOQ model depending on the assumptions made about the inventory
system. In this section we will describe three model versions, including the basic EOQ
model, the EOQ model with non instantaneous receipt and the EOQ model with
shortages
The simplest form of the EOQ model on which all other model versions are based
is called the Basic EOQ Model It is essentially a single formula for determining the
optimal order size that minimises the sum of carrying costs and ordering costs.
The basic EOQ model is applicable to procurement situation in which an item is
purchased from another company. This EOQ model is based on several conditions or
assumptions:
1.
2.
3.
4.

The use rate is uniform and known (i.e. constant demand),

The item cost does not vary with the order size ( i.e. no quantity discounts),
All the order is delivered at the same time (i.e. no back-order conditions),
The lead-time is known well enough that an order can be timed out to arrive
when inventory is zero, but no stock-outs occur),
5. The cost of holding is a linear function of the number of items held (i.e. no
economies of scale in holding costs).
The problem is deterministic that is there is no uncertainty or probability to
consider, where these conditions are met. Some of these assumptions differ from the
typical real-world situation. The basic EOQ model is oversimplified for some
situations, but it is use successfully by many firms with only a few establishments.
First we develop the basic formula. The basic EOQ model is a mathematical model
that uses symbols to represent relevant costs.
The objective of the EOQ is to minimise the total annual cost of inventory factors
for the item under consideration. A graphical model of inventory levels can classify
these costs over time, as in Fig.1. Notice every triangle is the same shape. The diagonal
lines all have the same slope, because the use rate is considered to be the same over
time. The inventory level goes to zero at the end of each cycle, because of the
assumption that shipments can be timed to arrive at just this moment. An order will be
placed when the inventory level reaches the "Re-Order Level (Ro), so the inventory is
exhausted at the end of the lead-time (t lt).
Reorder Level = Use Rate x Lead-Time
Ro

= c tlt

136

The heights of all the triangles are the same, because the orders that arrive
should all be the same size, since the entire shipment arrives each time and all other
conditions are assumed to be the same throughout the cycles.
Knowing how the order size affects the inventory level enables us to write an
equation and to derive a formula for inventory costs in terms of the order size X.
The symbols that will be uses are as follows:
X = Quantity ordered each time an order is placed,
X0 = Economic order quantity,
E = Increase in cost from holding one more unit for a year,
(E = Zp, where Z is the holding cost as a percentage and p is the cost of
one unit.)
C = Annual demand or number of units used in a year,
B = Ordering cost, or additional costs incurred by placing and receiving one
more order.
Total Inventory Costs = Total Ordering Costs + Total Carrying Costs
Total Ordering Costs = [Number of orders per year} x [The cost of an order]
=
N
x
B
=
C/X
x
B
Total Carrying Costs = [Average inventory held] x [The cost to hold an item
for a year]
=
X/2
x
E
Therefore Total Inventory Costs;

Ke = (C/X) B + (X/2) E

Our objective is to find the EOQ, which order quantity that will result in a
minimum total inventory costs. The minimum is reached by taking the derivative of the
equation and set it equal to zero.
Ke

= - (C/X2) B + E/2 =0

CB/X2 = E/2
Xo = {(2CB)/E}
(in units)
or
Xo = {(2CB)/(Zp)}
(in units)
Notice that demand and holding cost must be expressed for identical time basis.
Monthly demand over annual holding cost, for example, will give the wrong answer.
Monthly demand over holding cost however would also be correct.

137

At the EOQ, ordering costs and holding costs will be equal. That is minimum
total inventory costs is twice as much as ordering or holding costs. From the derivative
of Ke;
CB/X2 = E/2
(C/X)/B = (X/2)E

The rate of increase of holding costs equals the rate of decrease of ordering
costs at the EOQ.
In the following we shall derive, three more EOQ formulas. Each of these
produces the same answer, but in different units. Some inventory systems prefer to
consider inventory purchasing in terms of orders per year(No), others would rather
deal in terms of Units per economic order (XO), The number of days supply (to)
to purchase at one time is a more convenient form for other users, while the number
of Monetary Units per economic order (XO.p), fits other inventory system best.
Cost (MU)

Total Inventory Cost

(

Min.cost

x
c
E B)
2
x

Holding Cost
(

x
E)
2

Ordering Cost (

EOQ

c
B)
x

Order Quantity (X)

Fig.2: Identifying the Economic Order Quantity

Example 12:
Tarhan Bal, owner of computer village, needs to determine an optimal ordering

138

policy for Porto-Exec computers. Annual demand for the computers is 28000 MU and
carrying cost is 23%. Tarhan has estimated order costs to be 48 MU/order. What is the
optimal MU per order?
Solution:
Annual Demand = C*p = 28000 MU/year.
Carrying cost = z= 23%
Ordering cost = B = 48 MU/order
X0 (MU) = (2CpB)/Z = ( 2*28000*48)/0.23 = 3418.62 MU/order.
Optimum Number of Orders Per Year
Total Ordering Cost/Year = NB
Total Carrying Cost/Year = (C/N)(1/2)E
NB = (C / N ) (1/2)E
N2 =

CE
2B

No =

(CE)/2B

or

No =
(CpZ)/(2B)

Example 13:
Sergio Farmerson experiences an annual demand of 220000 MU for quality
golf balls at Magusa Golf Supply Co. It costs Sergio 30 MU to place an order and his
carrying cost is 18%. How many orders/year should Sergio place for the balls?
Solution:
N0 = CE/2B = Czp/2B = 220000*0.18/ 2*30 = 25.69 = ~ 26 Orders/year.
Example 14:
Anatolia Motors uses 25000 gear assemblies each year and purchases them
3.40 MU each. It costs 50 MU to process and receive an order, and
inventory can be carried at a cost of 0.78 MU per unit year.
a) How many assemblies should be ordered at a time?
b) How many orders per year should be placed?

139

Solution :
a) Economic Order Quantity = X0 = (2CB)/E =
= 1790 assemblies
b) Orders per year = N0 = C/Xo = 14 Orders / year

(2(25000)(50))/0.78

EXAMPLE 15:
A Konya Stockyard uses about 200 bales of hay per month. It pays a broker 80
MU per order to locate a supplier and handle the ordering and delivery arrangements.
Its own storage and handling costs are estimated at 30% per year. Each bale is
estimated to cost 3MU. What is the most Economical Order Quantity?
Solution:
Economic Order Quantity = X0 =

2CB/Zp

The purchase price is relevant for computing carrying charges (only) and they
must be in the same units as demand. We will (arbitrarily) use months.
XO =

{(2(200)(800)}/{(0.30)(3)/12} =

653 bales

Optimum Number of Days Supply Per Order

Total Ordering Cost/Year = Total Carrying Cost/Year
1/To

C/(1/To) E

(CToE)/2

B/To

2B/EC

= To2

T0 =

or

To =
{(2B)/(CE)}

2B
(year)
C pZ

(year)

Optimum Number of Monetary Units Per Order

Xo =

(2CB)/E

Xop =

Xo =
{(2BC)/Zp}

X0 (MU) =

2C p B
Z

(in money unit)

(2CB)/(Zp)

or

t0 =

2B
(days)
CE

140

Applying the EOQ Model to Production Process

The concept that there is one best pattern of ordering to minimise annual
inventory costs can be adapted to the production process. For instance, there are many
companies, which produce certain items among their product lines in lots or batches
instead of manufacturing at a constant rate all year long. These firms incur a Set-up
Cost each time a batch is produced. Set-up Cost, (s), is roughly equivalent to the
Ordering Cost, (B), per order already treated. It consists of:
1. Engineering Cost of setting up the production lines or machines,
2. Paperwork Cost of processing the work order and authorising production,
3. Ordering Cost to provide raw materials for the batch or order.
The company also incurs carrying costs. The formulas are quite similar to the
Economic Order Quantity model. This time we call it Optimal Lot Size model.
Example 16:
EMU uses 96000 MU annually of a particular reagent in the chemistry
department labs. The purchasing department of the EMU estimates the ordering cost at
45 MU and thinks that the university can hold this type of inventory at an annual
storage cost of 22% of the purchase price. How many months` supply should the
purchasing department order at one time to minimize total annual cost of inventory?
Solution:
t 0 = 12 2B/CZp = 12 2*45/ 96000*0/22 = 0.784 months` supply.
Example 17:
A toy manufacturer uses approximately 32000 silicon chips annually. The chips
are used at a steady rate during the 240 days a year that the plant operates. Annual
holding cost is 0.60 MU/chip and ordering cost is 24 MU. Determine:
a. Optimal order size
b. The number of workdays in an order cycle
Solution:
a.

X0 = 2CB/E = 2*32000 *24/0.6 = 1600 chips/order

b.

t0 = X0/C = 1600 chips /32000 chips/year = 1/20 year = 1/20 *240 days
= 12 days.

141

EOQ Model
Economic Order Quantity =X0=

OLS Model
(2CB)/E

Optimal Lot Size=Q0 = (2Cs)/E

[ s = set up cost /order (run) ]

Xo = (2CB)/(Zp)
[Z = percentage of average inventory value]
[p = value of the product ]

Qo =

Xo (in MU) =

Qo ( in MU ) =

(2CpB)/Z

(2Cs)/(Zp)

(2C p s ) / Z

No =

(CE)/(2B)

No =

(2CE)/(2s)

No =

(2CpZ)/(2B)

No =

(2C.p.Z)/(2s)

No = C/Xo
To =

No = C/Qo

(2B)/(CE)

or t o = 365

To =

(2B)/(CE)

To = Q0/C

(2B)/(CpZ)

or to =365

To =

(2B)/(CpZ)

(2s)/(CpZ)

(2s)/(CpZ)

Total Inventory Cost Model for EOQ and OLS Model

The total annual inventory cost associated with EOQ is;
Ke = Total ordering cost + Total Carrying cost
Ke = (C/X)B + (X/2)E
Ke =
or

or to = 365

(2s)/(CE)

To = Xo/C
To =

(2s)/(CE)

(2CBE)

Ke =

(2CpZB)

or to = 365

142

The total annual inventory cost associated with OLS is

Ke = Total set-up cost + Total carrying cost
Ke = (C/Q)s + (Q/2)E
Ke =

or

(2CEs)

Ke =

(2CpZs)

EXAMPLE 18:
One of the top-selling items in the container group at the museums gift shop is
a birdfeeder. It is especially designed to prevent even the cleverest squirrel from
stealing any of the birdfeed. Mr. Ali Caliskan estimates that weekly sales are 18
feeders, which translates into 936 per year (or 18 feeders / week). The purchase cost is
60 MU/unit and Mr. Caliskan estimates that its costs 25% of an items value to hold
one unit inventory for a year or, in this case, that it costs 15 MU (or 60 MU x 0.25).
The supplier gives no quantity discounts. The cost of placing an order is estimated to
be 45 MU. The current policy is to place an order every five months.
a) Find the total annual inventory cost according to the current policy.
b) Find the total annual inventory cost according to the EOQ model and interpret the
results.
Solution:
a)

Ke = (X/2)E + (C/X)B = [{(936/12) 5}/2]15 + [{936/{(936/12) 5}]45

Ke = 3 033MU

b)

XO =

(2CB)/E

{2(936)(45)}/15

= 74.95 = ~74 feeders

To = Xo/C = 75/936 = 0.08 year or 0.96 months or 29 days.

Ke =

(2CBE)

(2(936)(45)(15)

= 1124.1 MU

Savings = 3033 1124 = 1909 MU costs less than current policy of placing an
order every 5 months.
Carrying Cost Components
If carrying costs consists of two components:
1. Ei = Interest cost per unit-year on the average inventory investment
2. Es = Storage space cost per unit-year to accommodate X units

Economic Order Quantity, which includes both these terms;

Ke = Total Ordering Cost +Total Interest Cost + Total Storage Cost

143

(C/X) B + (X/2)Ei + X Es

Upon differentiating and setting the first derivative equal to zero, the order
quantity is now
0 = - (CB)/X2 + Ei/2 + Es
XO =

(2CB) / (Ei 2 Es )

EXAMPLE 19:
A manufacturer requires 600 printed circuit boards per year and estimates an
ordering cost of 20 MU per order. Inventory is financed by short-term loans at
approximately 10%, which work out to a carrying charge of 0.10 MU/unit/year based
upon the average inventory.
Storage costs, based upon adequate space for maximum inventory, are 0.025
MU/unit/year and the purchase price is 1 MU/unit.
a)
b)
c)
d)

What is the most economical order quantity?

What is the total annual cost of the inventory?
How many orders are placed per year?
What is the maximum inventory level?

Solution:
a)
Xo =
Units/order

(2CB) /(Ei 2Es)

{[2(600)(20)]/[0.10 2(0.025)]}

b)

Ke =

c)

No = C/X = 600/400 = 1.5 order/year = 3 orders every 2 year

d)

Imax = Xo = 400 Units / order

{2CB(Ei 2Es)}

{2(600)(20)(0.10 2(0.025))}

= 400

= 60 MU

EXAMPLE 20:
A hamburger chain has a local retail outlet that uses 730 cases of 0.21 paper
cups annually. Ordering costs are 15 MU, carrying costs are 30% of average inventory
investment; and a case costs 12 MU. Delivery lead-time is known with certainty to be
five days. Establishing the optimal operating doctrine
Xo =
=

(2CB)/(Zp)
{2(730)(15)/0.3(12)}

Ro

= c tlt
= (730/365) 5
Ro = 10 Cases

144

= 77.99
Xo = 78 Cases
EXAMPLE 21:
A television manufacturer requires 24000 two-cm long pieces of wire every
month for assembly. Ordering costs are estimated at 42 MU and the cost of carrying is
25% of the unit price, which is 0,08 MU. Assuming delivery instantaneous, find the
reorder point and economic order quantity.
Solution :
X0 =

(2CB)/(Zp)

{(2(240000 42)(12))/(0.25x0.08)}

= 34 779.3

wires
R0 = c tlt = 0
EXAMPLE 22:
The Dokuz Eylul University location of McDonalds uses 120 units of 0.2L per
cups per each day. McDonalds plans to be open 360 days a year. The cups cost 0.10
MU/dozen ordering costs are 5 MU/order and carrying costs are 50 % of the item cost
(since space is a premium).
a) Find the EOQ if delivery instantaneous.
b) Currently cups are ordered every 30 days. Relate current ordering quantity, optimal
order quantity, current total costs, and optimal total costs. What does it mean?
Solution:
a)

X0=

b)

Current total inventory cost = Ordering cost + Carrying cost

Current total inventory cost = 5 12 ( orders ) + 0.05(3600/12)(1/2)
= 67.50 MU

[{2(120/12)(360)(5)}/{(0.5)(0.10)}]

Total Inventory Cost at EOQ Ke =

MU

= 848.53 =~ 849 Dozens

[(2(120/12)(360)(5)(0.5)(0.10)]

= 42.43

Obviously Mc Donalds can save 25.07MU by using EOQ. A saving more than %37.
EXAMPLE 23:
Azim Manufacturing produces bolt-lock-nut assemblies for use in the
construction of its compact automobiles. The compacts are manufactured and sold as
gas savers, and the company has had an increased demand for the automobile since its
introduction early last year.
Each automobile requires 100 of these assemblies, and management has
determined that manufacturing is preferable to purchasing.

145

On the basis of last years sales, demand for the current year estimate to be 125000
automobiles (there is only one style).
Each production run for the assemblies require a set-up that costs 100 MU; this
expense covers general maintenance and operator time. The assemblies are carried in
inventory at an estimated cost of 0.004 MU/assembly). If management is willing to
accept the use of the classical inventory model and to apply the resulting economic
production lot size,
a) How many assemblies should be manufactured on each production run?
b) What is the total annual cost on this policy?
Solution:
(2Cs)/E
Q0=
=
assemblies/production run

[(2(125 000 x 100)(100)]/0.04

250

000

This production/inventory policy will result in a total annual inventory cost of

Ke=

2CsE

[2(125 000 x 100)(100)(0.04)]

= 10 000 MU

Thus the total annual (minimum) cost of the optimal. Inventory policy, as
determined by the use of the classical model, is 10,000 MU.
EXAMPLE 24:
Lady Sales Corporation functions as both a wholesale and retail outlet for a
popular ladies cosmetic kit. To meet customer for the kit, the management of Lady
Sales utilises the classical inventory model in determining its order policy.
Lady estimates that its sales for the current year will equal 250000 kits. Each
kit consists of lipstick, perfume and body lotion and wholesales for 1250 MU per kit.
On the basis of the costs incurred for insurance and other miscellaneous items,
management allocates 10 % of the wholesale price as the cost of carrying inventory. In
addition, the cost of preparing an order for mailing to the manufacturer is 10
MU/order.
How many of these kits should Lady order each time and how many times if its
objective is to minimise to the total annual cost of its inventory policy?
Solution:
X0=

(2CB)/(Zp)

{2(250000)(10)}/(0.10)(12.50)

= 2 000 Kits/order

N0= C/Xo = 250 000/2 000 = 125 Orders

Ke=

(2CpZB)

{2(250000)(10)(0.10)(12.50)}

= 2 500 MU

Ke = Total ordering cost = 125 orders x 10 MU = 1 250 MU

146

Ke = Total carrying cost = (2000/2)(0.10)(12.50)= 1 250 MU

t0= X0/C = (2000/250000)365 = 2.92 3 Days
EXAMPLE 25:
CIVAS Manufacturing produces and sells steel bolts that are used in truck
assemblies. These bolts are used in quantity that a four week lead time is required if the
bolt assembly division is to meet its expected annual level of sales, currently set at
100000 units.
The cost of set-up is 20 MU, and each unit carried in inventory costs CIVAS
0.01 per year.
a. Determine the EOQ/OLS and the reorder point. Assume a 50-week per year
production schedule.
b. Find the optimal number of orders/runs per year.
c. Determine the optimal time-period between orders/runs.
d. Calculate the total annual inventory cost.
Solution:
C = 100 000 Units/year
S = 20 MU/set-up
E = 0.01 MU/unit/year
Lead time = 4 weeks
a.
Q0 =

(2Cs)/E

{2(100 000)(20)}/0.01

= 20 000 Units

R0 = average periodic demand symbol lead time

=Cweekly tlead-time
= 100 000/50 x 4 = 8 000 Units
According to the given data, CIVAS should initiate a production order when its
inventory level has been reduced to 8000 units. The production order should be for
20000 units.
b.
N0 = C/X = 100 000/20 000 = 5 runs/year
c.
t0 = 50 (1/N) = 10 weeks
d.
Ke = 2CsE = 2(100 000)(20)(0.01) = 200 MU/year
Example 26:
The Gul Carpet Discount Store in Izmir stocks carpet in its warehouse and sells
it through an adjoining showroom. The store keeps several brands and styles of carpet
in stocks; however its biggest seller is Demir Carpet. The store wants to determine the
optimal order size and total inventory cost for this brand of carpet given an estimated
annual demand of 10000 m. of carpet; an annual carrying cost of 0.75MU/m, and an
ordering cost of 150MU. The store would also like to know the number of orders that
will be made annually and the time between orders (i.e. the order cycle) given that the
store is open everyday except Sunday, Republic Day and 1 st Day of Sacrifice Holly Day

147

(which is not on a Sunday)

Solution:
E = 0.75 MU/m
B = 150MU/orders
C = 10000 metres
The optimal order size is computed as follows:
X0=

(2CB)/E

2(2000)(150)/0.75

= 2000 Metres

The total annual inventory cost is determined either by substituting X into the
total inventory cost formula
Ke= (C/Xo)B + (Xo/2)E = (10000/2000)150 + (2000/2)0.75 = 1500 MU
or
Ke= {2CBE} = {2(10000)(150)(0.75)} = 1500 MU
The number of orders per year is computed as follows.
Number of per orders per year = No =

C
10000
=
= 5 orders/year
X
2000

Given that the store is open 311 days annually (365 days mines 52 Sundays,
republic day and first day of holly sacrifice day) the order cycle is determined as
follows.
Order cycle time = to = (Xo/C) 311 = (2000/10000)(311) = 62.2 store days
EXAMPLE 27:
Azim Plumbing Supply Co. stocks thousands items sold to regional plumbers,
contractors and retailers. Mr. Demir, the firms general manager, wonders how much
money could be saved annually if EOQ were used instead of the firms present rules of
thumb. He instructs an inventory analyst to conduct an analysis of one material only
(Material #1713, a brass valve) to see if significant savings might result from using
EOQ.
The inventory analyst develops the following estimates from accounting
information:
C = 10 000 valves / year,
E = 0.40 / valve / year,

X1 = 400 valves / order (present order quantity)

B = 5.50 MU/order.

a) Calculate the present annual inventory cost.

b) Calculate EOQ and the total annual inventory cost, if EOQ were employed.
c) Find the estimated annual savings and interpret.
Solution :
a) The present annual inventory cost.
Ke1 = (C/X1)B + (X1/2)E = (10000)(400)(5.5) + (400/2)(0.4) = 217.50 MU

148

b) EOQ :
XO =

(2CB)/E

(2x10000x5.5)/0.4

= 524.4 Valves

The total inventory cost if EOQ were employed:

Ke2 =

2CBE

{2(10000x 5.5 x 0.4)}

= 209.76 MU

c) The estimated annual savings in inventory costs:

Savings: Ke1 Ke2 = 217.50 209.76 = 7.74 MU
The analyst concluded that if the annual savings on this one material to the
thousands of items in inventory, the savings from EOQ would be significant.
Example 28:
A local distributor for a national tire company expects to sell approximately 9600
steel belted radial tires of a certain size next year. Annual carrying cost is 16 MU/ tire
and ordering cost is 75 MU/ order. The distributor operates 288 days a year.
a. What is the EOQ?
b. How many times per year does the store reorder?
c. What is the length of an order cycle?
d. What is the total annual cost if the EOQ is ordered?
Solution:
a. X0 = (2CB)/E = (2*9600*75)/16 = 300 tires/order
b. Orders per year = N0 = C/X0 = 9600/300 = 32 orders
c. t0 = X0/C = 300/9600 = 1/32 of a year = 1/32 * 288 = 9 working days.
or
T0 = 1/N= 1/32 yr and 1/32 * 288 = 9 working days.
d. TC inventory = Carrying cost + Ordering cost
Ke = C/x *B+ x/2*E
Ke = 9600/200*75 + 300/2*16
Ke = 4800 MU
or
Ke= 2CBE= 2*9600*75*16 = 4800 MU.
Carrying cost sometimes stated as a % of the purchase price of an item rather
than as a MU amount per unit. However, as long as the % is converted into a MU
amount, the EOQ formula is still appropriate.

149

Example 29:
ABC manufacturing assembles security monitors. It purchases 3600 black and
white cathode ray tubes a year at 65 MU each. Ordering costs are 31 MU and annual
carrying costs are 20% of the purchase price. Compute the optimal quantity, the
number of orders, cycle time of inventory, and the total annual inventory cost. Verify
total carrying cost = total carrying cost.
Solution:
C = 3600 Cathode tubes /yr
B= 31 MU/order
Z = 20%
p = 65 MU/tube
X0 = 2CB/Z.p = 2*3600*31 /0.20*65 = 131 cathode tubes/order
N0 = C/X0 = 3600 /131 = 27.48 orders = ~ 27 orders
t0 = X0/C = 131 /3600 = 0.03639 yr = 0.03639*365 = 13.28 days = ~ 13 days.
Ke= 2CBzp = 2*3600*31*0.20*65 = 1704 MU
Ke = C/X .B+ X/2*Z.p
Ke = 3600 /131*31 + 131/2*0.20*65
Ke = 852 + 852
Ke = 1704 MU
Example 30:
A local artisan uses supplies purchased from an overseas supplier. The owner
believes the assumptions of the EOQ model are met reasonably well. Minimization of
inventory costs is her objective. Relevant data from the files of the craft firm are annual
demand (C) = 240 units, ordering cost (B) = 42 MU/ unit/year.
1. How many should she order at one time?
2. How many times per year will she replenish its inventory of this material?
3. What will be the total inventory costs associated with this material?
4. If she discovered that the carrying cost had been overstated and was in reality
only 1 MU/unit-year, what is the corrected value of EOQ?

150

Solution:
C= 240 units/year
B= 42 MU/order
E= 4 MU/unit-year
1. X0 = 2CB/E = 2*240*42/4 = 70.99 = ~ 71 units /order
2. N0 = C/X0 = 240/71 = 3.38 times/year
3. Ke= 2CBE= 2*240*42*4 = 283.97 MU/year
4. X0 = 2CB/E = 2*240*42/1 = 141.99 = ~ 142 units
Ke= 2CBE= 2*240*42*1 = 142 MU/year.
Example 31:
Ground Coffee shop uses 3 kg of a specialty tea weekly, each kg costs 16 MU.
Carrying costs are 2 MU/kg/week because space is very scarce. It costs the firm 7 MU
to prepare an order. Assume the basic EOQ model with no shortages applies. Assume
52 weeks/year.
a. How many kg should Ground to order at a time?
b. What is the total annual inventory cost?
c. How many orders should Ground place annually?
d. How many days will there be between orders? (assume 310 operating days)
Solution:
a. X0 = 2CB/E = 2*3*7/2 = 4.58 kg/order
b. Ke= 2CBE= 2*3*7*2 = 9.165 MU/week & 9.165 * 52 = 476.59 MU
c. N0 = C/X0 = 3*52/4.58 = 34.06 times/year
d. t = 1/N*310 = 1/34.06 * 310 = 9.1 = ~ 9 days.