Question

Imtiaz Super Store sells Blue Band Margarines. Its annual demand is 108,500 units. The shop incurs ordering cost of Rs 650/= order, irrespective of the order size. They buy it at Rs 150 per unit. The carrying cost is 12% on average inventory investment plus rent, insurance, property tax, and supervision for each unit is Rs 3. The maximum sale per day is 360 units. It takes 5 days to receive these items from supplier after placement of order quantities. The annual working days of Store are 350 days.
Required:                                                                                                            
i). Determine the Economic order quantities (EOQ)
                                                                                                                                                                  Marks: 2
ii). Determine Safety stock maximum.
                                                                                                                                                                  Marks: 1

iii). Determine Reorder point levels
                                                                                                                                                                  Marks: 2
iv). Total annual inventory cost (Total annual ordering cost and total annual carrying cost)
                                                                                                                                                                  Marks: 2
v). A Supplier offers 1% discount to Imtiaz Supper Store, if they purchase the goods at least at 10,000 units at a time instead of above EOQ level (Part-i). Should they accept this offer? Please advice to management with relevant comparative workings.
                                                                                                                                                                  Marks: 2
vi). Why Economic order quantities may be wrong some time for any particular item to purchase in a given situation?

Answer 1

i).Economic order quantity = square root of [(2 x demand x ordering costs) ÷ carrying costs]

Annual demand =108500
Ordering cost =650
Carrying cost =21
= square root of (2*108500*650/21)
=2592 Units
ii). Determine Safety stock maximum.
Safety stock = (Maximum daily usage * Maximum lead time in days) – (Average daily usage * Average lead time in days).
=(360-310)*5

=250 units

iii)Reorder Point = (Average Daily Usage x Average Lead Time in Days) + Safety Stock

=(310*5)+250

=1800 units

iv)Total Inventory cost= demand *cost+no of orders*order cost+carrying cost*demand

=108500*150+(108500/2592)*650+21*108500

=rs.1,85,80,800

vi)The EOQ model assumes that demand is constant and that inventory is depleted at a predictable rate.

The biggest problem with assumptions of steady demand and steady sales in the EOQ model is that it doesn’t allow you to account for fluctuations in demand during holidays or particular seasons.

when the basic assumptions themselves prove invalid, the EOQ Model is inevitable to give wrong estimates