Nepal Trade Link expects to sell 7,200 pieces of small calculator this year. The cost of placing an order from its supplier is Rs 250. Each unit costs Rs 50 and carrying costs are 20 percent of the purchase price. a. What is the economic order quantity? b. What is the total inventory cost? c. If supplier offers 1 percent quantity discount for the order size of 1,800 pieces of calculator, should the discount offer be accepted?
Question
Nepal Trade Link expects to sell 7,200 pieces of small calculator this year. The cost of placing an order from its supplier is Rs 250. Each unit costs Rs 50 and carrying costs are 20 percent of the purchase price. a. What is the economic order quantity? b. What is the total inventory cost? c. If supplier offers 1 percent quantity discount for the order size of 1,800 pieces of calculator, should the discount offer be accepted?
Solution
a. The Economic Order Quantity (EOQ) is the number of units that a company should add to inventory with each order to minimize the total costs of inventory—such as holding costs, order costs, and shortage costs. The EOQ formula is:
EOQ = sqrt((2DS)/H)
where: D = demand rate (7,200 pieces) S = order cost (Rs 250) H = holding cost per unit per year (20% of Rs 50 = Rs 10)
So, EOQ = sqrt((27200250)/10) = 600 units.
b. The total inventory cost is the sum of the order cost and the holding cost. The order cost is the number of orders per year times the cost per order, and the holding cost is the average inventory level times the holding cost per unit.
The number of orders per year = D/EOQ = 7200/600 = 12 orders. The average inventory level = EOQ/2 = 600/2 = 300 units.
So, the total inventory cost = (12250) + (30010) = Rs 6,000.
c. If the supplier offers a 1 percent quantity discount for the order size of 1,800 pieces, the unit cost decreases to Rs 50 * 0.99 = Rs 49.5. However, the order size is larger than the EOQ, which means the holding cost will increase.
The new holding cost per unit = 20% of Rs 49.5 = Rs 9.9. The new number of orders per year = D/order size = 7200/1800 = 4 orders. The new average inventory level = order size/2 = 1800/2 = 900 units.
So, the new total inventory cost = (4250) + (9009.9) = Rs 10,410.
Since the new total inventory cost with the discount is higher than the original total inventory cost without the discount, the discount offer should not be accepted.
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