Question

A financial manager at Textbook Brokers, Inc. has estimated that it costs $30 to place an order from a major publisher. Further, she estimates that it costs $0.30 to hold each book. Textbook Brokers sells 75,000 books each 120 day period. In the past, the firm has ordered 4,000 books per delivery run. Calculate the difference in the total inventory cost (per period) if the firm moves from an order quantity of 4,000 books to the economic order quantity.

Answer 1

Economic order quantity is the order quantity of inventory required to minimize the cost of inventory management. EOQ is used under continuous inventory management mechanism

in which the level of inventory is monitored at all times and a fixed quantity is ordered each time the inventory level reaches a specific reorder point.

By EOQ we need to minimize the total inventory costs –

Total costs = Ordering costs + Holding costs

Deriving economic order quantity from this =

EOQ = SQRT(2 × Quantity × Cost Per Order / Carrying Cost Per Order)

In the mentioned problem –

Cost per order = 30

Holding cost = 0.30

Quantity = 75000

From the above formula, Economic order quantity comes to be = 3872.98 ~3873

Demand during the 120 day period is 75,000, hence number of orders required = 75,000/3873 = 19.36

Total inventory costs by using EOQ = ordering costs + holding costs = 19.36*30 + 3873*0.3 = 1,742.85

When the order size was 4000,

Number of orders required = 18.75

Total inventory costs = ordering costs + holding costs = 18.75*30+ 4000*0.3 = 1762.5

Difference in inventory costs = 1762.5 – 1742.85 = $19.65