UBS, GURGAON

Executive MBA Program

Course on Operations Management (EMB – 108)

Handout on some numerical problems in Inventory Management

(Prepared by: A. Ramachandran, Course Instructor)

An simple inventory problem

Example: Saba Switchgears Pvt. Ltd. requires 2,000 units of power spring every year. The unit
cost of this item is Rs.200. The holding cost per unit per year is 20 percent of unit cost. The
ordering cost is Rs.400 per order. The company is considering the following three procurement
policies:

Policy I: Place four orders of equal size.

Policy II: Place an order for 1000 units each time, and avail a 10 percent discount on the price
per unit.
Policy III: Follow the EOQ concept.

Which is the best policy for Saba to implement?

We evaluate each policy as follows:

Policy I: Four orders of equal size in a year => 500 units per order.
Hence, total ordering cost = 4(400) = Rs.1,600
Inventory holding cost = (500/2)(0.2)(200) = Rs.10,000
Purchase price for 2000 units = 2000(200)= 400,000.

Hence, total cost of the inventory system = Rs.411,600.

Policy II: There will be two orders in a year, each of size 1000 units, so the total ordering cost =
Rs.800.
Price per unit = (0.9) (200) = Rs.180.
Inventory holding cost = (1000/2) (0.2) (180) = 18,000.
Purchase cost for 2000 units = 2000(180)= 360,000.

Hence, total cost of the inventory system = Rs.378,180.

Policy III: EOQ = Sqrt {2(400)(2000)/40} = 200.

Total ordering cost = 10 (400) = Rs.4,000.
Inventory holding cost = (200/2) (0.2) (200) = 100 (40) = 4,000
Purchase price for 2000 units = 2000(200)= 400,000.

Hence, total cost of the inventory system = Rs.408,000.

Obviously, Policy II is the best.
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Handout on some numerical problems in Inventory Management (prepared by
A. Ramachandran, Course Instructor) 1
EOQ under price discount on larger orders – an example

The annual demand for an item is 4800 units. Ordering cost is Rs.500 per order. Inventory
carrying cost is 24% of purchase price per unit per year. The price breaks are:

Quantity Price per unit (Rs.)

0 ≤ Q1 < 1200 10
1200 ≤ Q2 < 2000 9
2000 ≤ Q3 8

Find the optimal order size. If the ordering cost reduces by Rs.200 per order, what is the optimal
order size?

Annual demand, d = 4800.

Ordering cost per order, a = Rs.500.
Inventory carrying cost (ICC) per unit per year, h = (0.24 ) (unit cost).

Consider p3 = Rs.8.00
Q3* = Sqrt {(2 x 500 x 4800)/(0.24 x 8)} = 1581, lies in 1200 ≤ Q2 < 2000 slab.

Hence consider p2 = Rs.9.00

Q2* = Sqrt {(2 x 500 x 4800)/(0.24 x 9)} = 1491, lies in 1200 ≤ Q2 < 2000 slab.
Hence, order size could be 1491, or the next price-break point, i.e. 2000.

Total cost at Q = 1491 is given by

(9 x 4800) + (500 x 4800/1491) + (0.24 x 9 x 1491/2) = Rs.46,420 approx.

Total cost at Q = 2000 is given by

(8 x 4800) + (500 x 4800/2000) + (0.24 x 8 x 2000/2) = Rs.40,320 approx.

As total cost at Q = 2000 is lower, optimal order quantity is 2000.

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Handout on some numerical problems in Inventory Management (prepared by
A. Ramachandran, Course Instructor) 2