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EOQ Assumptions
Types
1. Raw Materials
2. Bought Out Parts
3. WIP
4. Finished Goods
5. Maintenance repair and operating stores
6. Tools
7. Miscellaneous
Important terms
Demand
Order Cycle
Lead Time
Safety Stock
Inventory Turnover
Re-Order Level
Reorder Quantity
Inventory Holding Costs
Reasonably Typical Profile
% of
Category Inventory Value
Housing (building) cost 6%
Material handling costs 3%
Labor cost 3%
Inventory investment costs 11%
Pilferage, scrap, & obsolescence 3%
Total holding cost 26%
EOQ Model
Annual Cost
Order Quantity
EOQ Model
Annual Cost
Holding Cost
Order Quantity
Why Order Cost Decreases
Holding Cost
Order (Setup) Cost
Order Quantity
EOQ Model
Annual Cost
Holding Cost
Order (Setup) Cost
Order Quantity
EOQ Model
Annual Cost
Holding Cost
Order (Setup) Cost
2 D C0
EOQ
Ch
D= Annual demand (units)
Co = Cost per order
Cp = Cost per unit
I = Holding cost (%)
H= Holding cost (Rs.) = I x C
EOQ Model Equations
2 DS
Optimal Order Quantity Q*
H
D
Expected Number Orders N
Q*
Working Days/Year
Expected Time Between Orders T
N
D D = Demand per year
d S = Setup (order) cost per order
Working Days/Year
H = Holding (carrying) cost
d = Demand per day
ROP d L L = Lead time in days
EOQ
Example
Youre a buyer for Philips Coffee making
machine.
Philips needs 1000 coffee makers per
year. The cost of each coffee maker is Rs
3000. Ordering cost is Rs500 per order.
Carrying cost is 40% of per unit cost. Lead
time is 5 days. The company is open 365
days/yr.
What is the optimal order quantity & ROP?
Example
2 D Co
EOQ
Ch
D = 1000
Cp = 3000
Co = Rs. 500
I = 40%
Ch= C x I
Ch = 3000 x 0.4 EOQ = ?
The Basic EOQ Model To order inventory
t Time
Figure 12.6
Production Order Quantity
Model
Q = Number of pieces per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
t = Length of the production run in days
Annual inventory
= (Maximum inventory level)/2
level
Maximum Q Q d
inventory level =p d =Q 1
p p p
2
2DS
Q =
H[1 - (d/p)]
2DS
Q*p =
H[1 - (d/p)]
Production Order Quantity
Example
D = 1,000 units p = 8 units per day
S = $10 d = 4 units per day
H = $0.50 per unit per year
2DS
Q* =
H[1 - (d/p)]
2(1,000)(10)
Q* = = 80,000
0.50[1 - (4/8)]
2DS
Q* =
annual demand rate
H 1
annual production rate
Quantity Discount Models
Reduced prices are often available when
larger quantities are purchased
Trade-off is between reduced product cost and
increased holding cost
D Q
TC = S+ H + PD
Q 2
Quantity Discount Models
A typical quantity discount schedule
Discount Discount
Number Discount Quantity Discount (%) Price (P)
1 0 to 999 no discount $5.00
2 1,000 to 1,999 4 $4.80
Table 12.2
Quantity Discount Models
Steps in analyzing a quantity discount
1. For each discount, calculate Q*
2. If Q* for a discount doesnt qualify, choose
the smallest possible order size to get the
discount
3. Compute the total cost for each Q* or
adjusted value from Step 2
4. Select the Q* that gives the lowest total
cost
Quantity Discount Models
Total cost curve for discount 2
Total cost
curve for
discount 1
Total cost $
0 1,000 2,000
Figure 12.7
Order quantity
Quantity Discount Example
Calculate Q* for every discount 2DS
Q* =
IP
2(5,000)(49)
Q1* = = 700 cars/order
(.2)(5.00)
2(5,000)(49)
Q2* = = 714 cars/order
(.2)(4.80)
2(5,000)(49)
Q3* = = 718 cars/order
(.2)(4.75)
Quantity Discount Example
Calculate Q* for every discount 2DS
Q* =
IP
2(5,000)(49)
Q1* = = 700 cars/order
(.2)(5.00)
2(5,000)(49)
Q2* = = 714 cars/order
(.2)(4.80) 1,000 adjusted
2(5,000)(49)
Q3* = = 718 cars/order
(.2)(4.75) 2,000 adjusted
The EOQ Model with Shortages
Shortage
Shortage = S/Q
What we needed
Area = * (S/Q) * S
*base* height = * (Q-S) * (Q-S)/Q
2 = * S 2 /Q
= * (Q-S) /Q
(to p20)
In the EOQ model wth shortages, the assumption that shortages
cannot exist is relaxed.
Assumed that unmet demand can be backordered with all demand
eventually satisfied.
Shortage
Shortage = S/Q
What we needed
On hand = (Q-S)/Q 32
The EOQ Model with Shortages
Total cost Total shortage costs total carrying costs total ordering cost
S2 (Q S ) 2 D
Total inventory cost : TC Cs Cc Co
2Q 2Q Q
2CoD Cs Cc
Optimal order quantity : Q*
Cc Cs
Cc
Shortage level : S * Q *
Cc Cs
33