Question

Ericson & Jade Electronics are manufactures of Music instruments made from brass. The purchase manager has estimated that 600Kgs of brass is required every year. The current order size is 50Kg made every month.

It takes $10 to place one order and carrying cost per unit per anum is about $2. The supplier has made the following offer to the purchase manager:

Order Size	Price per Kg ($)
Up-to 50	11
51 – 60	10
61 – 80	8.5
81 – 100	8
100 – 200	7
200 – 500	6.5

The purchase manager has suggested that the company should purchase full 600Kg of brass to avail the discount.

REQUIRED: Perform the following actions:

         i.            Calculate the EOQ.

       ii.            Analyze and evaluate the argument of purchase manager by showing necessary calculations and decide upon the order size (50Kg, EOQ, 200Kg or 600Kg).

Answer 1

(i)

EOQ = (2 x U x P)/S

where,

EOQ = Economice order quantity

U = Annual usage of material = 600 kg

P = Cost of placing an order = $10

S = Storage/Carrying cost per unit per annum = $2

EOQ = (2 x 600 x 10)/2

= 6,000

= 77.46 kg

But EOQ is not taken into fraction. Hence, EOQ =78Kg

(ii)

	Order size = 50 kg.	EOQ	Order size = 200 Kg.	Order size = 600 Kg.
Material cost per kg. ($)	11	8.5	7	6.5
Total material cost ($) (i)	600 x 11 = 6,600	600 x 8.5 = $5,100	600 x 7 = 4,200	600 x 6.5 = 3,900
Number of orders	600/50 = 12	600/78 = 8	600/200 = 3	600/600 = 1
Ordering cost per order ($)	10	10	10	10
Annual ordering cost ($) (ii)	12 x 10 = 120	8 x 10 = 80	3 x 10 = 30	1 x 10 = 10
Annual Carrying cost ($) (iii)	50 x 2 x 1/2 = 50	78 x 2 x 1/2 = 39	200 x 2 x 1/2 = 100	600 x 2 x 1/2 = 300
Total annual cost (i) + (ii) + (iii)	$6,770	$5,219	$4,330	$4,210

Number of orders in a year = Annual requirement/order size

Annual ordering cost = Number of orders x ordering cost per order

Annual storage cost = Order size x Storage cost per unit per annum x 1/2

Conclusion: Since annual cost is minimum when 600kg is purchased in one order, hence purchase manager has suggested the best