FINANCIAL MANAGEMENT

INVENTORY MANAGEMENT PROBLEMS – SOLUTION

Economic Order Quantity (EOQ) model and Reorder point Model

PROBLEMS:
Bulldogs Corp. projects its sales to be P60,000,000., which equates to 12,000 units this year. As a result of holding
inventories, insurance, storage, taxes and other cost are incurred amounted to P1.60 per unit, which includes allocation
of loss due to theft and obsolescence and opportunity cost of cash tied up. Every time Bulldogs Corp. makes an order,
P6.00 is incurred. On the average it takes 6 days to make and receive an order. (Use 360 days a year)

1. What is the economic order quantity (EOQ)? 300

2. What is the average inventory? 150
3. How much is the annual cost of carrying inventory? 240
4. How many orders will be placed during the year? 40
5. How many days will each order last? 9 days
6. How much transaction cost are incurred each year? 240
7. How much is the annual cost of inventory? 480

8. How long is the normal lead time? 6 days

9. How many units of inventory is the average daily usage? 33.33
10. What is the normal lead time usage? 200
11. What amount of inventory is reorder point (what is the reorder point)? 200 units
Note:
• In EOQ formula, make sure all the variable as in their respective units
• The number of days per year (360 or 365) must be stated on the problem
• Annual Cost of inventory is the same as the total cost of inventory and it comprises of annual ordering and
carrying cost
• Analyzing more deeply, the EOQ formula is almost the same as the concept of the Baumol Model of cash
management – they just differ on the variables used. Instead of annual demand of inventory under EOQ, the
Baumol model uses the annual demand of cash. Transaction cost in Baumol model is ordering cost in EOQ;
Holding cost in Baumol model is carrying cost of inventory in EOQ. The bottom line is they have the same
concept.
• Normal lead time is given in the problem (from ordering to receiving of goods ordered)
• Normal lead time usage is, inlay man’s term, is how many units of inventory is used on the no. of days span of
the company’s lead time.
• In the scenario above the NLT usage is the ROP because the demand and lead time is both constant
• It is noted that the annual cost of carrying inventory and transaction cost are incurred each year (annual
ordering cost) is the same since they are computed using the quantity computed under EOQ model.
Assuming Bulldogs Corp.’s inventory may take as 7.5 days to respond:
1. How much safety stock should the company keep? 50 units

2. What is the economic order quantity (EOQ)? 300 units

3. What is the average inventory? 200
4. How much is the annual cost of carrying inventory? 320
5. How many orders will be placed during the year? 40
6. How many days will each order last? 9 days
7. How much transaction cost are incurred each year? 240
8. How much is the annual cost of inventory? 560

9. How long is the normal lead time? 6 days

10. How many units of inventory is the average daily usage? 33.33
11. What is the normal lead time usage? 200
12. What amount of inventory is reorder point (what is the reorder point)? 250 units
Note:
• Under the assumption on this part of the problem, safety stock is needed since variability is present in
demand or lead time (NLT is 6 days, but it could stretch as far as 7.5 days)
• The annual cost of carrying inventory increases since the company have safety stocks
• The ROP will now be the NLT usage plus the Safety Stock (SS) since the safety stock should always be on hand.