An EOQ Example

Determine optimal number of needles to order

D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days

Total annual cost = Setup cost + Holding cost

D Q
TC = S + H
Q 2
1,000 200
TC = ($10) + ($.50)
200 2

TC = (5)($10) + (100)($.50) = $50 + $50 = $100

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 Robust Model

 The EOQ model is robust

 It works even if all parameters
and assumptions are not met
 The total cost curve is relatively
flat in the area of the EOQ

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 An EOQ Example
Management underestimated demand by 50%
D = 1,000 units 1,500 units Q* = 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days

D Q
TC = S + H
Q 2
1,500 200
TC = ($10) + ($.50) = $75 + $50 = $125
200 2

Total annual cost increases by only 25%

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 An EOQ Example
Actual EOQ for new demand is 244.9 units
D = 1,000 units 1,500 units Q* = 244.9 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year T = 50 days

D Q
TC = S + H
Q 2 Only 2% less
1,500 244.9 than the total
TC = ($10) + ($.50) cost of $125
244.9 2
when the
TC = $61.24 + $61.24 = $122.48 order quantity
was 200

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 Class Test and its Solution
A company manufactures and sells a seasonal product.
Based on the sales forecast that follows, calculate a
level production plan, quarterly ending inventories, and
average quarterly inventories. Assume that the average
quarterly inventory is the average of the starting and
ending inventory for the quarter. If inventory carrying
costs are $3 per unit per quarter, what is the annual cost
of carrying this anticipation inventory? Opening and
ending inventories are zero.

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 Class Test and its Solution
Test “A”
Quarter - Quarter - Quarter - Quarter -
Total
1 2 3 4
Sales 1000 2000 3000 2000 8000

Production 2000 2000 2000 2000 8000

Ending
0 1000 1000 0 0
Inventory
Average
500 1000 500 0
Inventory
Inventory Cost 1500 3000 1500 0 $ 6000

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 Class Test and its Solution
Test “B”
Quarter - Quarter - Quarter - Quarter -
Total
1 2 3 4
Sales 1200 2250 3100 1800 8350

Production 2088 2088 2088 2088 8352

Ending
0 888 726 -286
Inventory
Average TIME TO TAKE DECISION
Inventory
Inventory Cost

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 Reorder Points
 EOQ answers the “how much” question
 The reorder point (ROP) tells when to
order
Demand Lead time for a
ROP = per day new order in days
=dxL
D
d = Number of working days in a year

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 Class Test 03
A company wants to develop a level production plan for
a family of products. The opening inventory is 100 units,
and an increase to 160 units is expected by the end of
the plan.
The demand for each period is given in what follows.
How much should the company produce each period?
What will be the ending inventories in each period? All
periods have the same number of working days.

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 Class Test 03

Period 1 2 3 4 5 6 Total

Forecast Demand 100 120 130 140 120 110 720

Planned Production 130 130 130 130 130 130 780

Planned
100 130 140 140 130 140 160
Inventory

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 Class Test 04
A company wants to develop a level production plan for
a family of products. The opening inventory is 500 units,
and a decrease to 300 units is expected by the end of the
plan.
The demand for each of the periods is given in what
follows. All periods have the same number of working
days. How much should the company produce each
period? What will be the ending inventories in each
period? Do you see any problems with the plan?

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 Class Test 03

Period 1 2 3 4 5 6 Total

Forecast Demand 1300 1200 800 600 800 1000 5700

Planned Production 917 917 917 917 917 917 5500

Planned
500 117 -167 -50 267 383 300
Inventory

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 Class QUIZ 02
Given the following data, calculate a level production
plan, quarterly ending inventory, and average quarterly
inventory.
If inventory carrying costs are $6 per unit per quarter,
what is the annual carrying cost? Opening and ending
inventory are zero.
If the company always carries 100 units of safety stock,
what is the annual cost of carrying it?

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 QUIZ - 02
Quarter - Quarter - Quarter - Quarter -
Total
1 2 3 4
Forecast
5000 8000 8000 9000 30000
Demand
Production 7500 7500 7500 7500 30000
Ending
0 2500 2000 1500 0
Inventory
Average
1250 2250 1750 750
Inventory
Inventory Cost 7500 13500 10500 4500 $36000

Annual cost of carrying safety stock = $6 × 4 × 100 = $2,400

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 Reorder Point Curve
Q*
Inventory level (units)

Slope = units/day = d

ROP
(units)

Time (days)
Figure 12.5 Lead time = L
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 Reorder Point Example
Demand = 8,000 DVDs per year
250 working day year
Lead time for orders is 3 working days
D
d=
Number of working days in a year

= 8,000/250 = 32 units

ROP = d x L
= 32 units per day x 3 days = 96 units

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 The EOQ Model – With Cost of items
Q = Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the Inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year
C = Cost per unit

Ordering costs = Carrying costs

D Q
S = CH
Q 2
Solving for Q*
2DS = Q2HC
Q2 = 2DS/CH
Q* = 2DS/CH
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 How to Reduce Lot Size
Q* = 2DS/CH
The EOQ formula has four variables.
 The EOQ will increase as the annual demand (D) and the
cost of ordering (S) increase,
 and it will decrease as the cost of carrying inventory (H)
and the unit cost (C) increase.
The annual demand (D) is a condition of the marketplace and
is beyond the control of manufacturing.
The cost of carrying inventory (H) is determined by the
product itself and the cost of money to the company. As such,
it is beyond the control of manufacturing.

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 How to Reduce Lot Size (Cont’d)
Q* = 2DS/CH
The unit cost (C) is either the purchase cost of the SKU or the
cost of manufacturing the item. Ideally, both costs should be
as low as possible.
In any event, as the unit cost decreases, the EOQ increases.
The cost of ordering (S) is either the cost of placing a
purchase order or the cost of placing a manufacturing order.
The cost of placing a manufacturing order is made up from
production control costs and setup costs.
Anything that can be done to reduce these costs reduces the
EOQ.

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 VARIATIONS OF THE EOQ MODEL
There are several modifications that can be made to the basic
EOQ model to fit particular circumstances.
Two that are often used are
 the monetary unit lot-size model, and
 the non instantaneous receipt model.

Monetary Unit Lot Size

The EOQ can be calculated in monetary units rather than
physical units. The same EOQ formula can be used, but the
annual usage changes from units to dollars.
DA = annual usage in dollars.
S = ordering costs in dollars
H = carrying cost rate as a decimal or a percent
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VARIATIONS OF THE EOQ MODEL (Cont’d)

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Example:

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Example:
An item has an annual demand of 25,000 units, a unit
cost of $10, an order preparation cost of $10, and a
carrying cost of 20%. It is ordered on the basis of an
EOQ, but the supplier has offered a discount of 2%
on orders of $10,000 or more. Should the offer be
accepted?

SOLUTION:

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Example: (Cont’d)
SOLUTION:

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