An oil enginemanufacturer purchases lubricants at the rate of Rs.

42 per piece from a

vendor.The requirement of these lubricants is 1,800 per year. What shouldbe the order quantity per
order, if the cost per placement of anorder is Rs.16 and inventory carrying charge per rupee per year is
20 paise.

Solution : GivenD = 1,800*42 = 75,600units, Co = Rs.16/ order and Ch = 0.20per unit / year. ThenQ* =
34,776 units. Thus, the optimuminventory quantity of lubricant at the rate of Rs.42per lubricant =Q*/42
= 83 lubricants.

1 Given:
A manufacturing company purchases lubricants at the rate of Rs. 42 per piece
from a vendor.
The requirement of these lubricants is 1800 per year.
2 To find:
What should be the order quantity per order if the cost per placement of an
order is Rs. 16 and inventory carrying charges per rupee per year is only 20
paise???
3 Solution:
To solve the above-given problem we will use the following formula:

Where:
D = Annual demand per unit
S = ordering cost per purchse order
H = Holding cost per unit
Here we have,
The annual requirement or demand (D) of the lubricants is,
= 1800 × Rs. 42
= Rs. 75600
The ordering cost per order (S) = Rs. 16
The holding cost per unit per year (H) = Rs. 0.20
Now, on substituting the given values in the formula of EOQ, we get

∴ The optimum inventory quantity is = ≈

Thus, the order quantity per order should be approximately 83 lubricants.

2. Solution:
Given data are:
Number of lubricants to be purchased, D = 9000 parts per year
Cost of part, Cs= Rs. 20
Procurement cost, C3= Rs. 15 per order
Inventory carrying cost, CI = C1= 15% of average inventory per year
= Rs. 20 × 0.15 = Rs. 3 per each part per year
Then, optimal quantity (EOQ), Q0= √2C3D
= √C1
Q0= √2 ×15× 300
= √3
= 300 units
and Optimum order interval, (t0) =
Q0in years
D = 300
9000 = 1 years
30 = 1 × 365
30 =122 days
Minimum average cost=
=√2C3DC1
=√2 ×3 ×15 ×9000
= Rs. 900
If the company follows the policy of ordering every month, then the annual
ordering cost is = Rs 12 × 15 = Rs. 180
Lot size of inventory each month = 9000/12 = 750
Average inventory at any time = Q/2 = 750/2 = 375
Therefore, storage cost at any time = 375 × C1 = 375 × 3 = Rs. 1125
Total annual cost = 1125 + 180 = Rs. 1305
Hence, the company should purchase 300 parts at time interval of 1/30 year
instead of ordering 750 parts each month. The net saving of the company will
be = Rs. 1305 – Rs. 900 = Rs. 405 per year.
Solution:
Given data are:
Number of lubricants to be purchased, D = 9000 parts per year
Cost of part, Cs= Rs. 20
Procurement cost, C3= Rs. 15 per order
Inventory carrying cost, CI = C1= 15% of average inventory per year
= Rs. 20 × 0.15 = Rs. 3 per each part per year
Then, optimal quantity (EOQ), Q0= √2C3D
= √C1
Q0= √2 ×15× 300
= √3
= 300 units
and Optimum order interval, (t0) =
Q0in years
D = 300
9000 = 1 years
30 = 1 × 365
30 =122 days
Minimum average cost=
=√2C3DC1
=√2 ×3 ×15 ×9000
= Rs. 900
If the company follows the policy of ordering every month, then the annual
ordering cost is = Rs 12 × 15 = Rs. 180
Lot size of inventory each month = 9000/12 = 750
Average inventory at any time = Q/2 = 750/2 = 375
Therefore, storage cost at any time = 375 × C1 = 375 × 3 = Rs. 1125
Total annual cost = 1125 + 180 = Rs. 1305
Hence, the company should purchase 300 parts at time interval of 1/30 year
instead of ordering 750 parts each month. The net saving of the company will
be = Rs. 1305 – Rs. 900 = Rs. 405 per year.

Or

ILLUSTRATION 5:
A manufacturing company purchase 9000 parts of a machine for its annual requirements ordering
for month usage at a time, each part costs Rs. 20. The ordering cost per order is Rs. 15 and carrying
charges are 15% of the average inventory per year. You have been assigned to suggest a more
economical purchase policy for the company. What advice you offer and how much would it save the
company per year?
SOLUTION:
Given data are:
Number of lubricants to be purchased, D = 9000 parts per year
Cost of part, Cs= Rs. 20
Procurement cost, C3= Rs. 15 per order
Inventory carrying cost, CI = C1= 15% of average inventory per year
= Rs. 20 × 0.15 = Rs. 3 per each part per year
Then, optimal quantity (EOQ), Q0=
√2C3D
√C1

Q0=
√2 ×15× 300
√3
= 300 units

and Optimum order interval, (t0) =

Q0in years
D
=

300
9000
=

1 years
30
=
1 × 365
30
=122 days

Minimum average cost=

=√2C3DC1
=√2 ×3 ×15 ×9000

= Rs. 900

If the company follows the policy of ordering every month, then the annual ordering cost is = Rs 12
× 15 = Rs. 180

Lot size of inventory each month = 9000/12 = 750

Average inventory at any time = Q/2 = 750/2 = 375

Therefore, storage cost at any time = 375 × C1 = 375 × 3 = Rs. 1125
Total annual cost = 1125 + 180 = Rs. 1305
Hence, the company should purchase 300 parts at time interval of 1/30 year instead of ordering 750
parts each month. The net saving of the company will be = Rs. 1305 – Rs. 900 = Rs. 405 per year.
ILLUSTRATION 5:
A manufacturing company purchase 9000 parts of a machine for its annual requirements ordering
for month usage at a time, each part costs Rs. 20. The ordering cost per order is Rs. 15 and carrying
charges are 15% of the average inventory per year. You have been assigned to suggest a more
economical purchase policy for the company. What advice you offer and how much would it save the
company per year?
SOLUTION:
Given data are:
Number of lubricants to be purchased, D = 9000 parts per year
Cost of part, Cs= Rs. 20
Procurement cost, C3= Rs. 15 per order
Inventory carrying cost, CI = C1= 15% of average inventory per year
= Rs. 20 × 0.15 = Rs. 3 per each part per year
Then, optimal quantity (EOQ), Q0=
√2C3D
√C1

Q0=
√2 ×15× 300
√3
= 300 units

and Optimum order interval, (t0) =

Q0in years
D
=

300
9000
=

1 years
30
=

1 × 365
30
=122 days

Minimum average cost=

=√2C3DC1
=√2 ×3 ×15 ×9000

= Rs. 900

If the company follows the policy of ordering every month, then the annual ordering cost is = Rs 12
× 15 = Rs. 180

Lot size of inventory each month = 9000/12 = 750

Average inventory at any time = Q/2 = 750/2 = 375

Therefore, storage cost at any time = 375 × C1 = 375 × 3 = Rs. 1125
Total annual cost = 1125 + 180 = Rs. 1305
Hence, the company should purchase 300 parts at time interval of 1/30 year instead of ordering 750
parts each month. The net saving of the company will be = Rs. 1305 – Rs. 900 = Rs. 405 per year.

3.1.1.1 3. Example

A retailer expects to sell about 200 units of a product per year. The storage space
taken up in his premises by one unit of this product is costed at £20 per year. If the
cost associated with ordering is £35 per order what is the economic order quantity
given that interest rates are expected to remain close to 10% per year and the total cost
of one unit is £100.

We use the EOQ formula,

EOQ = (2Rco/ch)0.5

Here R=200, co=35 and the holding cost ch is given by

ch = £20 (direct storage cost per unit per year) + £100 x 0.10 (this term the money
interest lost if one unit sits in stock for one year)

i.e. ch = £30 per unit per year

Hence EOQ = (2Rco/ch)0.5 = (2 x 200 x 35/30)0.5 = 21.602

But as we must order a whole number of units we have that:

EOQ = 22
We can illustrate this calculation by reference to the diagram below which shows
order cost, holding cost and total cost for this example.

With this EOQ we can calculate our total annual cost from the equation

Total annual cost = ch(Q/2) + co(R/Q)

Hence for this example we have that

Total annual cost = (30 x 22/2) + (35 x 200/22) = 330 + 318.2 = £648.2

Note: If we had used the exact Q value given by the EOQ formula (i.e. Q=21.602) we
would have had that the two terms relating to annual holding cost and annual order
cost would have been exactly equal to each other

i.e. holding cost = order cost at EOQ point (or, referring to the diagram above, the
EOQ quantity is at the point associated with the Holding Cost curve and the Order
Cost curve intersecting).

i.e. (chQ/2) = (coR/Q) so that Q = (2Rco/ch)0.5

In other words, as in fact might seem natural from the shape of the Holding Cost
and Order Cost curves, the optimal order quantity coincides with the order
quantity that exactly balances Holding Cost and Ordering Cost.

Note however that this result only applies to certain simple situations. It is not true (in
general) that the best order quantity corresponds to the quantity where holding cost
and ordering cost are in balance.

4 Package solution

We can also solve this problem using the package, the input and output being shown
below. Note here that the package can deal with more complicated factors than we
have considered in the simple example given above.

Note the appearance here of the figure of 20,000 relating to material cost. This is
calculated from using 200 units a year at a unit cost of £100 each. Strictly, this cost
term should have been added to the total annual cost equation (ch(Q/2) + co(R/Q)) we
gave above. We neglected it above as it was a constant term for this example and
hence did not affect the calculation of the optimal value of Q. However, we will need
to remember to include this term below when we come to consider quantity discounts.

5 Example
Suppose, for administrative convenience, we ordered 20 and not 22 at each order -
what would be our cost penalty for deviating from the EOQ value?

With a Q of 20 we look at the total annual cost

= (chQ/2) + (coR/Q)

= (30 x 20)/2 + (35 x 200/20) = 300 + 350 = £650

Hence the cost penalty for deviating from the EOQ derived value of 22 and ordering
20 at each order is £650 - £648.2 = £1.8

Note that this is, relatively, a very small penalty for deviating from the EOQ value.
This is usually the case in inventory problems i.e. the total annual cost curve is flat
near the EOQ so there is only a small cost penalty associated with slight deviations
from the EOQ value (see the diagram above).

This is an important point. Essentially we should view the EOQ as a ballpark figure.
That is it gives us a rough idea as to how many we should be ordering each time.
After all our cost figures (such as cost of an order) are likely to be inaccurate. Also it
is highly unlikely that we will use items at a constant rate (as the EOQ formula
assumes). However, that said, the EOQ model provides a systematic and quantitative
way of getting an idea as to how much we should order each time. If we deviate far
from this ballpark figure then we will most likely be paying a large cost penalty.

The above cost calculation can also be done using the package - see below.
 4. A toy manufacturer uses 48,000 rubber wheels per year for its popular dump truck series.� The
firm makes its own wheels, which it can produce at a rate of 800 per day.� The toy trucks are
assembled uniformly over the entire year.� Carrying cost is $1 per wheel a year.� Set-up cost for a
production run of wheels is $45.� The firm operates 240 days per year.� Determine the:

Optimal run size? �wheels

carrying cost + set-up cost.� Thus you must first compute for

wheels

Cycle time

Run time

5. Example 2 (Economic Production Quantity Model) • A toy manufacturer uses 48000 rubber wheels
per year for its popular dump truck series. The firm makes its own wheels, which it can produce at a rate
of 800 p y er da . • The toy trucks are assembled uniformly over the entire year. Carrying cost is $1 per
wheel a year. Setup cost for a production run of wheels is $45. The firm operates 240 days per year.
Determine the

a. Optimal run size. b. Minimum total annual cost for carrying and setup. c. Cycle time for the optimal
run size. d. Run time.

D = 48000 wheels per year

S = $45 H = $1 per wheel per year

p = 800 wheels per day

u = 48000 wheels per 240 days, or 200 wheels per day

a. Optimal run size