Question

A company purchases a particular component from an external supplier. The demand for the component is estimated to be 475 units per month. The cost of placing an order with the supplier is £500. The component can be purchased from the supplier at a price per unit of £63 if so desired. However the supplier also offers a quantity discount such that if the company orders 800 or more in each order the price per unit is only £60. The warehousing cost of holding this component (per year) is estimated to be 8% of the price. The current interest rate is 4% per year. How many units should the company order each time it places an order and what would be the associated total cost per year? Clearly explain any procedure you use in arriving at your answer

Answer 1

Answer:

Above problem can be solved using EOQ model

Thus,

D = 475 units per month = 475 x 12 = 5700 units per year

S = 500

C = 63

I = 8%

Therefore, H = (8/100) x 63 = 5.04

Thus,

EOQ = 1064 units

Total cost per year = ordering cost + cost of component + holding cost

Ordering cost = (D/Q) x S = (5700/1064) x 500 = 2678.57

Holding cost = (Q/2) x H = (1064 / 2) x 5.04 = 2681.28

Cost of component = C x D = 63 x 5700 = 359100

Thus, Total cost = 2678.57 + 2681.28 + 359100 = 364459.85

Now, when C= 60 and EOQ = 800

Total cost per year = ordering cost + cost of component + holding cost

Ordering cost = (D/Q) x S = (5700/800) x 500 = 3562.5

Holding cost = (Q/2) x H = (800 / 2) x 5.04 = 2016

Cost of component = C x D = 60 x 5700 = 342000

Thus, Total cost = 3562.5 + 2016 + 342000 = 347578.5

Thus, by looking at the total cost, company should order 800 units which will cost them 347578.5.