Question

B. Inventory management 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

2.2 REQUIRED:

Study the information provided above under section B: Inventory management and answer the following questions:

2.2.1 Calculate the economic order quantity (EOQ). (4)

2.2.2 Calculate the total cost of the current ordering policy and determine the savings that could be made should Shop n Pay switch to using the economic order quantity model.

Answer 1

2.2.1 EOQ

EOQ (FORMULA IN THE PHOTO)

D ( ANNUAL DEMAND ) = 625000

Co (ORDERING COST PER ORDER) = 250

Ch (HOLDIND COSTS PER UNIT) = 5% OF 10 (PURCHASE PRICE) = 0.5

PURCHASE PRICE = SELLING PRICE - PROFIT

= 15 - 5 =10

EOQ (view uploaded image) = 25000

2.2.2

TOTAL COST UNDER CURRENT ORDERING POLICY

ORDER SIZE = 100000

NUMBER OF ORDERS = ANNUAL DEMAND / ORDER SIZE \

= 625000 / 100000 = 6.25 ORDER PER YEAR

ANNUAL ORDERING COSTS = NUMBER OF ORDERS PER YEAR  * ORDERING COST PER ORDER

= 6.25 * 250 = 1562.5

AVERAGE INVENTORY = BUFFER INVENTORY + [ORDERING QUANTITY / 2 ]

= 35000 + (100000 / 2 )

= 85000

HOLDING COSTS OF AVERAGE INVENTORY = AVERAGE INVENTORY * HOLDING COST PER UNIT

= 85000 * 0.5 = 42500

PURCHASE PRICE = 625000 * 10

= 6250000

TOTAL PRICE = PURCHASE PRICE + HOLDING COSTS OF AVERAGE INVENTORY +

ANNUAL ORDERING COSTS

THEREFORE ; TOTAL PRICE = 6250000 + 42500 + 1562.5 = 6294062.5

TOTAL COST UNDER EOQ

ORDER SIZE = EOQ = 25000

NUMBER OF ORDERS = ANNUAL DEMAND / ORDER SIZE

= 625000 / 25000

= 25 ORDERS

ANNUAL ORDERING COSTS = NUMBER OF ORDERS PER YEAR  * ORDERING COST PER ORDER

= 25 * 250 = 6250

AVERAGE INVENTORY = BUFFER INVENTORY + [ORDERING QUANTITY / 2 ]

= 35000 + (25000 / 2)

= 47500

HOLDING COSTS OF AVERAGE INVENTORY = AVERAGE INVENTORY * HOLDING COST PER UNIT

= 47500 * 0.5

= 23750

PURCHASE PRICE = 625000 * 10

= 6250000

TOTAL PRICE = PURCHASE PRICE + HOLDING COSTS OF AVERAGE INVENTORY +

ANNUAL ORDERING COSTS

THEREFORE; TOTAL COSTS = 6250000 + 23750 + 6250

= 6280000

SAVINGS MADE IF CHANGED TO EOQ MODEL

= TOTAL COSTS UNDER CURRENT POLICY - TOTAL COSTS UNDER EOQ MODEL

= 6294062.5 - 6280000

= 14062.5

HOPE THIS WILL HELP YOU , COMMENT IF YOU NEED FURTHER CLARIFICATION