Question

1. A company manufactures a product from a raw material, which is purchased at ` 54 per kg. The company incurs a handling cost of ` 350 plus freight of ` 400 per order. The incremental carrying cost of inventory of raw material is Re. 0.50 per kg per month. In addition, the cost of working capital finance on the investment in inventory of raw material is `8 per kg per annum. The annual production of the product is 94,500 units and 2 units are obtained from one kg of raw material. Required : (i) Calculate the economic order quantity of raw materials. (ii) Advise, how frequently should orders for procurement be placed. (iii) If the company proposes to rationalize placement of orders on quarterly basis, what percentage of discount in the price of raw materials should be negotiated ?

Answer 1

1)
2 units = 1 kg of Raw material
94,500 units = (1kg x 94,500)/2	47250	kg
Annual consumption Requirement = A	47250	kg
Handling Cost & Freight Cost = O = ($350 + $400)	$750.00	Per Order
Carrying Cost per unit P.a + Cost of Investment p.a = C = (.50 x 12 month)+$8	$14.00	Per kg
EOQ = Sqrt((2 x A x O )/C)
EOQ = Sqrt((2 x 47250 x $750 )/$14)	2,250.00	Kg
2)
no. of orders for 1 year or 360 days = Annual Consumption/EOQ
no. of orders for 1 year or 360 days = 47,250/2250	21	orders
Frequency of Orders = 360 days/21	17.14	Days
3)
Quarterly basis = 4 orders per year
Quantity per Order = 47,250/4	11,812.5	Kg
Total cost when order size is 11,812 kg
Ordering cost = 4 x $750	$3,000.00
Carrying Cost = 11,812.5 x $14	$82,687.50	$85,687.50	a)
Total cost when order size is equal to EOQ
No of orders per year	21
Ordering Cost = 21 x $750	$15,750.00
Carrying cost = 2250/2 x $14	$15,750.00	$31,500.00	b)
Increase in cost due quarterly Orders (a) - (b)		$54,187.50
This increase be compensated by Discount
Reduction in per KG of purchase price = $54,187.50/47250	$1.15
% of Discount = $1.15/ $ 54 x 100	2.12%