1. A company manufactures a product from a raw material, which is purchased at `
ID: 2620286 • Letter: 1
Question
1. A company manufactures a product from a raw material, which is purchased at ` 54 per kg. The company incurs a handling cost of ` 350 plus freight of ` 400 per order. The incremental carrying cost of inventory of raw material is Re. 0.50 per kg per month. In addition, the cost of working capital finance on the investment in inventory of raw material is `8 per kg per annum. The annual production of the product is 94,500 units and 2 units are obtained from one kg of raw material. Required : (i) Calculate the economic order quantity of raw materials. (ii) Advise, how frequently should orders for procurement be placed. (iii) If the company proposes to rationalize placement of orders on quarterly basis, what percentage of discount in the price of raw materials should be negotiated ?
Explanation / Answer
1) 2 units = 1 kg of Raw material 94,500 units = (1kg x 94,500)/2 47250 kg Annual consumption Requirement = A 47250 kg Handling Cost & Freight Cost = O = ($350 + $400) $750.00 Per Order Carrying Cost per unit P.a + Cost of Investment p.a = C = (.50 x 12 month)+$8 $14.00 Per kg EOQ = Sqrt((2 x A x O )/C) EOQ = Sqrt((2 x 47250 x $750 )/$14) 2,250.00 Kg 2) no. of orders for 1 year or 360 days = Annual Consumption/EOQ no. of orders for 1 year or 360 days = 47,250/2250 21 orders Frequency of Orders = 360 days/21 17.14 Days 3) Quarterly basis = 4 orders per year Quantity per Order = 47,250/4 11,812.5 Kg Total cost when order size is 11,812 kg Ordering cost = 4 x $750 $3,000.00 Carrying Cost = 11,812.5 x $14 $82,687.50 $85,687.50 a) Total cost when order size is equal to EOQ No of orders per year 21 Ordering Cost = 21 x $750 $15,750.00 Carrying cost = 2250/2 x $14 $15,750.00 $31,500.00 b) Increase in cost due quarterly Orders (a) - (b) $54,187.50 This increase be compensated by Discount Reduction in per KG of purchase price = $54,187.50/47250 $1.15 % of Discount = $1.15/ $ 54 x 100 2.12%
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