ASSIGNMENT NO.

Economic Order Quantity

Q1. Write a note on Economic order quantity

Ans:
Economic Order Quantity is defined as the optimal quantity of orders that minimizes total
variable costs required to order and hold inventory.

It is one of the oldest classical production scheduling models.

The framework used to determine this order quantity is also known as Wilson EOQ
Model or Wilson Formula.

The model was developed by Ford W. Harris in 1913.

Assumptions of EOQ

1. The ordering cost is constant.

2. The rate of demand is known, and spread evenly throughout the year.
3. The lead time is fixed.
4. The purchase price of the item is constant i.e. no discount is available
5. The replenishment is made instantaneously; the whole batch is delivered at once.
6. Only one product is involved.

Q2. Derive the expression for economic order quantity?

Ans:
Economic order quantity is the order quantity that minimizes total inventory holding costs and
ordering costs.

EOQ is the quantity to order, so that the sum of ordering cost and holding cost is at its minimum.
These costs will be equal to one another at the minimized cost point.
Variables used in EOQ are:

c = purchase price/ unit production cost

Q= order quantity

Q* = optimal order quantity

D= annual demand quantity

K= fixed cost per order/ setup cost

h= annual holding cost per unit also known as carrying cost or storage cost (capital cost,
warehouse space, refrigeration, insurance, etc. usually not related to the unit production cost)

The Total Cost function

Total Cost = purchase cost or production cost + ordering cost + holding cost-------------(i)
Purchase cost: This is the variable cost of goods: purchase unit price annual demand quantity.
i.e. (c D)
Ordering cost: This is the cost of placing orders and each order has a fixed cost K. i.e. (K D/Q)
Holding cost: the average quantity in stock (between fully replenished and empty) is Q/2, i.e.
(h Q/2)
TC = c D + D K + h Q ---------------------------------------------------------(ii)
Q 2
Taking the derivative of both sides of the equation and setting equal to zero to find the minimum
value of the function
0= -DK+h
Q2 2
Solving for Q gives Q* (the optimal order quantity):
Q*2 = 2 D K
h
Therefore,
Q* = 2DK ------------------------------------------------------------------------(iii)
h
Where, Q* is independent of c and it is a function of only K, D, h.
Q3.

Suppose annual requirement quantity (D) = 10000 units

Cost per order (K) = 2 Rs

Cost per unit (c)= 8 Rs

Carrying cost percentage (h/c) (percentage of c) = 0.02

Annual carrying cost per unit (h) = 0.16 Rs

Ans:

Economic order quantity = Q* = 2DK = 2 10000 2 = 500 units

h 8 0.02
Number of orders per year = D/Q* = 10000/500 = 20
Total cost = c D + K (D / Q*) + h ( Q*/2)
Total cost = 8 10000 + 2 (10000/500) + 0.16 (500/2) = 80080 Rs.
If the total cost for any order quantity other than 500(=EOQ), then the cost is higher.
For 600 units per order,
Total cost = 8 10000 + 2 (10000/600) + 0.16 (600/2) = 80081 Rs.
Similarly, for 300 order quantity
Total cost = 8 10000 + 2 (10000/300) + 0.16 (300/2) = 80091 Rs.

Q4.
Annual demand of bricks for contractor is 5200 units.
Fixed ordering cost is 10 Rs per order
Cost per brick is 2 Rs.
Holding cost is 20% of value on inventory per year
Suppose EOQ assumptions are hold i.e. constant demand, no lag or lead time and no
shortages. Then find the value of EOQ for bricks.
Ans:
D = Annual demand = 5200 units
K = fixed ordering cost = 10 Rs. Per order
c= cost per brick = 2 Rs.
 F = holding cost factor = 20% of value of inventory per year.

Annual carrying cost per unit (h) = 0.2 2 = 4

Economic order quantity = Q* = 2DK = 2 5200 10 = 510 units

h 2 0.2
Number of orders per year = D/Q* = 5200/510 = 10.2 = 11
Total cost = c D + K (D / Q*) + h ( Q*/2)
Total cost = 2 5200 + 10 (5200/510) + 4 (510/2) = 11522 Rs.
Q5.
A particular construction company purchases glass panels from one of its key suppliers. The
project engineer wants to determine the economic order quantity, to ensure tha annual inventory
cost is minimized. Also find out the variation in total annual cost require for glass panels
procurement. The following information was obtained from historical data
Annual requirement ( D ) = 7200 units
Set up cost ( K) = 100 Rs per order
Holding rate (F) = 20% per year
Unit cost ( c) = 20 Rs per unit
Order lead time = 6 days
Number of days per year = 360
Ans:

Economic order quantity = Q* = 2DK = 2 7200 100 = 600 units

h 20 0.20

Total annual inventory cost = annual purchase cost + annual order cost + annual holding cost
Annual purchase cost = c D = 20 7200= 144000 Rs.
Annual order cost (AOC) = K (D / Q*) = 100 (7200 / 600) = 1200 Rs.
Annual holding cost (AHC) = h (Q*/2) = h (Q*/2) = 20 0.2 (600/2) = 1200 Rs.
Total annual cost = 144000 + 1200 + 1200 = 146400 Rs.
Number of orders per year = D/Q* = 7200/600 = 12 orders
Time between orders = 360/12 = 30 days
 Percent variation in total annual cost:
Q (units) AOC AHC ATC Variation

(Rs.) (Rs.) (Rs.) (%)

K (D / Q) h (Q/2) = (2) + (3)

(1) (2) (3) (4) (5)

540 1333.33 1080.00 2413.33 0.56

550 1309.09 1100.00 2409.09 0.38

560 1285.71 1120.00 2405.71 0.24

570 1263.71 1140.00 2403.16 0.13

580 1241.38 1160.00 2401.38 0.06

590 1220.34 1180.00 2400.34 0.01

Q*=600 1200.00 1200.00 2400.00 0.00

610 1180.33 1220.00 2400.33 0.01

620 1161.29 1240.00 2401.29 0.05

630 1142.86 1260.00 2402.86 0.12

640 1125.00 1280.00 2405.00 0.21

650 1107.69 1300.00 2407.69 0.32

660 1090.91 1320.00 2410.91 0.45

Where,
Variation(%) = ATC (for Q) ATC (for Q*) 100
ATC (for Q*)

Draw the graph for Cost Vs Order showing AHC, AOC and ATC show the EOQ value