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**In this model, we assume that stock outs (and
**

backordering) are allowed.

In addition to previous assumptions, we assume that

sales will not be lost due to a stock out.

Because, we will back order any demand that can

not be fulfilled

B: Backordering cost per unit per year

b: The amount backordered at the time the next

order arrives

Q – b: Remaining units after the backorder is

satisfied

**Total Annual Cost = Annual Setup Cost + Annual
**

Holding Cost + Annual Backordering Cost

Annual Setup (Ordering) Cost = (D/Q) . S

Annual Holding Cost = (Average Inventory Level) . H

By using the graphical ratios, we know that:

T1 / T = (Q – b) / Q Therefore, if we replace

T1/T in the above equation we get

Average Inventory Level = (Q – b)2 / 2Q

By using the graphical ratios, we know that:

T2 / T = b / Q Therefore, if we replace T2/T in

the above equation we get

Average Backordering = b2 / 2Q and

We find optimum order quantity (Q*) and optimum

backordering quantity (b*) by taking the derivatives

of dTC/dQ = 0 and dTC / db = 0 and then putting

the values in their places.

Quantity Discount Model

A quantity discount is simply a reduced price (P) for

an item when it is purchased in LARGER quantities.

A typical quantity discount schedule is as follows:

Since the unit cost for the Third discount is the

lowest, We might be tempted to order 2000 or more

units.

However, this quantity might not be the one that

minimizes the Total Cost.

Remember that, As the quantity goes up, the

holding cost increasesHere, there is a trade off

between reduced product price (P) and increased

holding cost (H).

Total Cost = Setup Cost + Holding Cost + Product

Price (Cost)

Total Cost = DS / Q + QH / 2 + PD where P

is the price per unit

To determine the minimum Total Cost, we perform

the following process which includes 4 steps:

Step 1: Assume that

I: is a percentage value, and

I . P represents the holding cost as a percentage of

price per unit (P).

For each discount alternative, calculate a value of

Q* = [2DS / IP]1/2

Here, instead of using a value of H, the holding cost

is equal to I . P

That is, If the item is expensive (such as a Class A

Item), Its holding cost will be higher.

Since the price of item (P) is a factor in Annual

Holding Cost, we can no longer assume that the

holding cost is constant (such as H) when price

changes.

Step 2: For any discount alternative,

If the calculated optimum order quantity (Q*) is too

low to qualify for the discount range,

Then, Adjust the order quantity upward to the

lowest quantity that will qualify for the particular

discount alternative.

Step 3: Using the total cost (TC) equation above,

compute a total cost for every order quantity (Q).

Use the adjusted Q values.

Step 4: Select the discount alternative which has the

minimum Total Cost (TC).

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