Part 4:

QUANTITATIVE TECHNIQUES SOFTWARE GENERATED INFORMATION

Part 4.2:

Outcome 4: Use software-generated information to make decisions at operational, tactical and strategic levels in an organization. Assessment Criteria: 4.3 Prepare a spreadsheet to enable material requirements planning and calculate economic order quantities.

1. Fixed order-quantity models

Economic order quantity Production order quantity Quantity discount

EOQ

2. Probabilistic models 3. Fixed order-period models

a. b. c. d. e. f. g.

Known and constant stockholding cost Known and constant ordering cost Known and constant demand Known and constant lead time Instantaneous replenishment of material Constant price per unit /no discounts No stockouts

- associated with

1. Costs of holding stock

holding or carrying inventory over time

associated with costs of placing order and receiving goods

2. Costs of obtaining stock -

associated with running out of stock

3. Stock-out Costs -

cost of buying in price/ direct cost

4. Cost of Stock itself

Stock costs 1.

Costs of holding/ carrying stock

a) Interest on capital invested in the stock b) Warehousing/ Storage charges (rent, lighting, heating, refrigeration, air conditioning, etc.) c) Stores staffing, equipment maintenance and running costs d) Insurance, security e) Pilferage, vermin damage f) Deterioration and obsolescence

Stock costs 2.

Costs of obtaining stock

a) Clerical & administration cost associated with purchasing, accounting, and Goods Received Dept. b) Transportation costs

c) Cost associated with internal ordering

A company use 50,000 bulbs per annum which are RM7 each to purchase. The ordering costs are RM50 per order and carrying costs are 5% of purchase price per annum, i.e. it cost RM0.35 p.a to carry a widget in stock (RM7 x 5%) Various cost calculation: i. Total cost per annum = Co p.a + Cc p.a where Co p.a = No. of order x Cost per order No. of orders = Annual Demand/Order Quantity Cc p.a = Average stock level x Cc per item Average stock = Order quantity/ 2

Total cost per annum = Co p.a + Cc p.a

i. No. of orders = Annual Demand/Order Quantity = 50,000 / 5,000 = 10 times ii. Co p.a = 10 x RM50 = RM500

iii. Average stock = 5,000 / 2

iv. Cc p.a

= 2,500 units

= 2,500 x RM0.35 = RM875

** From various assumption of quantity order, we may plot the various cost in a graph as follows

Annual Cost

Minimum total cost

Order (Setup) Cost Curve Optimal Order Quantity

Order quantity

(EOQ)

 More units must be stored if more are ordered

Purchase Order Description Qty. Microwave 1

Purchase Order Description Qty. Microwave 1000

Order quantity

Order quantity

 Cost is spread over more units

Example: You need 1000 microwave ovens
1 Order (Postage RM 0.33)
Purchase Order Description Qty. Microwave 1000

1000 Orders (Postage RM330)

Purchase Order Purchase Order Purchase Order Description Qty. Purchase Order Description Qty. Description Qty.1 Microwave Description Qty. Microwave 11 Microwave Microwave 1

Order quantity

EOQ formula:

Ordering cost per order

EOQ

2 Co D Demand per cycle Cc Carrying cost per item

(per cycle) and carrying costs are A year is the usual period cost is expressed as a in others it is expressed

Notes: Always take care that demand expressed for the same time period. used. In some problems the carrying percentage of the value whereas directly as a cost per item.

Based on Illustration 3 Demand = 50,000 bulbs, Price per item = RM7 Ordering cost = RM50 per order, Carrying cost = 5% x RM7 = RM0.35

EOQ

2 Co D Cc

2 50 50,000 0.35

3779.64
3780 units

D q C Co Cc q 2

As q get larger: Annual ordering cost become smaller Annual holding cost become larger & Total annual inventory cost is minimised when the order quantity, q takes the value of EOQ

Where C = total ordering cost + total carrying cost Co = Annual ordering cost Cc = Annual carrying cost q = quantity order

Based on Illustration 3 Demand = 50,000 bulbs, Price per item = RM7 Ordering cost = RM50 per order, Carrying cost = 5% x RM7 = RM0.35

D q C Co Cc q 2

50,000 3780 50 0.35 3780 2

661.38 661.50 RM1322.88

Suppose that the present quantity order by this company is; a. 5000 bulbs or, b. 2000 bulbs If other cost are unchanged, calculate the present total annual cost incurred by each present quantity order?

50,000 5000 50 0.35 Cq 5000 5000 2

500 875 RM1375.00

50,000 2000 50 0.35 Cq 2000 2000 2

1250 350 RM1600

Total annual cost for quantity order based on calculated EOQ is the lowest compared to other two order quantities which are larger and smaller than the EOQ. These calculated cost proved that the EOQ minimise the balance of costs between inventory holding cost and re-order costs.

1. A company uses 100,000 units of EG per year which cost RM3 each. Carrying costs are 1% per month and ordering costs are RM250 per order. Currently, the company purchase this EG in batches of 7500 units each. Suggest the best quantity order for this company and explains the total cost saved by using EOQ.

2. A building materials supplier obtains its bagged cement from a single supplier. Demand is reasonably constant throughout the year and last year the company sold 2000 tones of this product. It estimates the cost of placing an order at around RM25 each time an order is placed, and calculates that the annual cost of holding inventory is 20% of purchase cost. The company purchases the cement at RM60 per tone. How much should the company order at a time? After calculating the EOQ the operations manager feels that placing an order using EOQ seems somewhat over-precise. Why not order at convenient tones?

EOQ

2 Co D Cc

2 250 100 ,000 12% 3 11785.11

11785 units

C EOQ

D q 100 ,000 11785 Co Cc 250 0.36 q 2 11785 2 2121.34 2121.30

RM 4242.64

C7500

D q Co Cc q 2

100 ,000 7500 250 0.36 7500 2 3333.33 1350

RM 4683.33

 Unrealistic assumption with the basic EOQ assumption is that the price per item remains constant Consider the costs associated with the normal EOQ and compare these costs with the costs at each succeeding discount point Find the best quantity to order

Financial consequences of discount

Three financial effect; Saving comes from lower price per item The larger order quantity means that fewer orders need to be placed so that total ordering costs are reduced. Increased costs arise from the extra stockholding costs caused by the average stock level being higher due to the larger order quantity.

1. Find EOQ using basic price 2. Compare the savings from the lower price and ordering costs and the extra stock-holding at each discount point, with the costs associated with the basic EOQ. - find various costs and saving comparisons based on EOQ

A company uses a special bracket in the manufacturer of its product which it orders from outside suppliers. The appropriate data are Demand 2,000 per annum Order cost RM20 per order Carrying cost 15% of item price Basic item price RM10 per bracket The company is offered the following discounts on the basic price: For order quantities 400 700 less 2% 800 1,599 less 4% 1,600 and over less 5% What is the most economical quantity to order?

No. 1. 2.

Order Quantity Discount

EOQ = 230 -

400 2%

800 4%

1600 5%

3.

Average No. of 2000 2000 2000 quantity 2000 Comparison 8.7 5Minimum 2.5 1.25 Order per annum Quantity, 230 EOQ 400 800 for each1600 entitled discount rate Average No. of 8 .7 2 .5 8.7 1.25 8.7 5 Order Saver per 6.2 times 7.45 times 3.7 times annum Ordering Cost Saving per annum Price Saving per item per annum Total gains
3.7 RM 20 RM 74 6.2 RM 20 7.45 RM 20 RM 124 RM 149

4. 5. 6.

RM 10 2% D RM 10 4% D RM 10 5% D RM 1000 RM 400 RM 800

RM 474

RM 924 RM1149

10 X 2% = RM0.20 Price after disc = 10 0.20 = RM9.80

No. Order Quantity 7. Stockholding Cost per annum

EOQ
230 10 2 15%

400

800

1600

800 1600 400 9.60 9.50 9.80 2 2 2 15% 15% 15% RM 172.50 RM 294 RM 576 RM 1140
294 172.50 576 172.50 1140 172.50 RM 121.50 RM 403.50 RM 967.50

8.

Additional Costs Incurred by Increased Order

9.

Net Gain/ Loss

RM 352.50 RM 520.50 RM181.50

What is the most economical quantity to order? 1600 buckets Why? Company will saved RM710 due to discount offered (5%) and less frequency of orders to made

EOQ

2 Co D Cc

2 20 2000 15% 10 230.94

230 brackets

KABANA Bhd buy 100,000kg per annum of barites, a raw materials. The company purchases this commodity in batches of 2,000kg and pays RM10 per kg. The cost of ordering is estimated at Rm70 and the cost of holding each kg in stock is estimated at 10% of the purchase costs. a. Calculate the economic order quantity b. How much money would be saved by ordering the EOQ rather than the present quantity?