Question

Company 4 has the following information relating to one of its inventory items: Buffer inventory level 100 units Re-order size 500 units Fixed order cost £100 Holding cost for one unit per year £2.50 Annual demand 20,000 units Purchase price £4 Calculate the cost of the current ordering policy and determine the saving that could be made by using the economic order quantity model.

Answer 1

The cost of the current ordering policy is £650 and the saving that could be made by using the economic order quantity model is -£3,785.

Step-by-step explanation:

The cost of the current ordering policy can be calculated by multiplying the number of orders placed in a year by the fixed order cost and adding the holding cost for one unit per year multiplied by the buffer inventory level. So, the cost of the current ordering policy is (20,000/500) * £100 + £2.50 * 100 units = £400 + £250 = £650.

The economic order quantity (EOQ) can be calculated using the formula EOQ = sqrt(2 * Annual demand * Fixed order cost / Holding cost per unit per year). In this case, the EOQ is sqrt(2 * 20,000 * £100 / £2.50) = sqrt(800,000) = 894 units.

The saving that could be made by using the EOQ model is the difference between the cost of the current ordering policy and the cost of ordering using the EOQ. So, the saving is £650 - [(20,000/894) * £100 + £2.50 * 894] = £650 - (22 * £100 + £2.50 * 894) = £650 - (£2,200 + £2,235) = £650 - £4,435 = -£3,785.