Oriental Trading Company decides to establish an EOQ for an item. The annual dem
ID: 393605 • Letter: O
Question
Oriental Trading Company decides to establish an EOQ for an item. The annual demand for the item is 400,000 units with a unit cost of $9. The ordering costs are $35 per order, and inventory carrying costs are 22%. The supplier offers a 2% discount on orders of 5,000 units. Solve for the purchase cost, the cost of ordering, the cost of carrying and the total cost for an order of 5,000 units and EOQ. You should present your results in tabular form comparing Q 5.000 and Q -EOQ. Determine which option is better and how much cost can be saved. (b) (16 marks)Explanation / Answer
Following are the relevant details for calculation of EOQ :
Annual demand = D = 400,000 units
Ordering cost = Co = $35
Annual unit inventory carrying cost = Ch = 22% of $ 9 = $1.98
Therefore , EOQ
= Square root ( 2 x Co x D/ Ch )
= Square root ( 2 x 35 x 400,000/ 1.98 )
= 3760.507 ( 3761 rounded to nearest whole number )
For order quantity = EOQ :
Annual purchase cost = Cost / unit x Annual demand = $9 x 400,000 = $3600000
Annual ordering cost = Ordering cost x Number of orders = Co x annual demand / EOQ = $ 35 x 400,000/ 3761 = $3722.41
Annual inventory carrying cost = Annual unit inventory holding cost x Average inventory = Ch x EOQ/2 = $1.98 x 3761/2 = $3723.39
Total cost = $3600000 + $3722.41 + $3723.39 = $3607445.80
For order quantity = 500 :
Unit purchase price ( because of 2% discount ) = 98% of $ 9 / unit = $8.82 / unit .
Therefore , annual unit inventory carrying cost = 22% of $8.82 = $1.94
Annual purchase cost = Cost / unit x Annual demand = $8.82 x 400,000 = $3528,000
Annual ordering cost = Ordering cost x Number of orders = Co x annual demand / order quantity = $ 35 x 400,000/ 5000 = $2800
Annual inventory carrying cost = Annual unit inventory holding cost x Average inventory = Ch x Order quantity / 2 = $1.94 x 5000/2 = $4850
Total cost = $3528,000 + $2800 + $4850 = $3535650
Since total cost for order quantity = 5000 is less, it is the better option.
Cost saved by exercising this option = $3607445.60 - $3535650 = $71795.60
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