Solution - 3

Demand rate : D units/year

Production cost : C /unit

Setup cost : A /lot

Holding cost : h dollars/unit/year

Lot Size : Q units

Lead time : L(Q)= aQ (a- constant)

Unit WIP cost : ω / year/ product

Costs per year = Setup cost + Production cost + Inventory holding cost + WIP cost + Backorder cost

Annual setup cost = A x

Annual production cost = C x D

Annual inventory holding cost = x h

Annual WIP cost = D x L(Q) x ω = aQDω

a) Annual cost function Y(Q) and optimal order quantity (Q*)

Annual cost function = Setup cost + Production cost + Inventory holding cost + WIP cost + Backorder cost
𝑨𝑫 𝑸𝒉
Annual cost function Y(Q) = 𝑸
+ CD + 𝟐
+ aDωQ

For Q* (optimum lot size), we find minimum of annual cost function by differentiating Y(Q) w.r.t Q
( )
=- + 0 + +aDω =0

= + aDω

Q2= ( )

Q=±

Optimal order quantity:

Q* =

b) Cost per each order interval (T*):

𝑨𝑫 𝑸𝒉
Cost per each order interval y(Q*) = Y(Q*)/ ( ) = Y(Q*) x = ( 𝑸 + CD + 𝟐
+ aDωQ) x

y(Q*) = A + CQ + + aωQ2

c) WIP cost is the cost of partially completed/ in-progress goods in the manufacturing process. This includes labour
cost, material cost and overheads.
WIP cost is directly dependant on the lead time, the lot size and the WIP cost per unit. As the lead time/ demand
increases, the WIP cost will also increase as the number of in-progress goods in each manufacturing cycle will
increase.