Chapter 2: Materials

Topic 1: E.O.Q (Economic Order Quantity)

Practice Questions

Question 1.
From the following information, calculate (a) Economic order quantity, (b) for EOQ, the
number of orders per year, (c) for EOQ how frequently should orders be placed, (d) for
EOQ, Total Ordering Cost, (e) for EOQ, Total Carrying Cost and (f) Total Annual Carrying
and Ordering Cost at that quantity.
Annual Consumption of input 48,000 units Purchase Price of input unit ₹ 25
Annual Carrying Cost 12% Ordering Cost per order ₹ 180

Solution:

2𝐴𝑂 2×48000×₹180
(a) EOQ = √ = √ = 2400 Units
𝐶 ₹3

Where,
A = Annual Demand
O = Ordering cost per order
C = Inventory carrying cost per unit per annum

Total Annual Consumption 48,000 Units

(b) No. of orders per year = = = 20 Orders
Order Size 2,400 Units

365 Days 365 Days

(c) Frequency of Orders = = = 18.25 days
No.of Order 20 Orders
Annual Consumption
(d) Total Ordering Cost = × Ordering Cost per order
Order Size
48,000
= 2,400
× ₹180 = ₹3,600

Order Size
(e) Total Carrying Cost = × Carrying Cost per unit p.a. = 2400/2 × ₹3 = ₹3,600
2

(f) Total Annual Carrying & Ordering Cost

𝐴𝑛𝑛𝑢𝑎𝑙 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑂𝑟𝑒𝑑𝑒𝑟 𝑆𝑖𝑧𝑒
=[( 𝑂𝑟𝑑𝑒𝑟 𝑆𝑖𝑧𝑒
× 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 𝑝𝑒𝑟 𝑜𝑟𝑑𝑒𝑟) + ( 2
× 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 𝑝. 𝑢. 𝑝. 𝑎 )]

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 48,000 2400
=( × ₹180 ) + ( × ₹3)
2,400 2

= ₹3,600 + ₹3,600
= ₹7,200

Question 2.

Compute E.O.Q. and the total variable cost for the following:
Annual Demand 5,000 units

Unit price 20.00

Order cost 16.00

Storage rate 2% per annum

Interest rate 12% per annum

Obsolescence rate 6% per annum

Determine the total variable cost that would result for the items if an incorrect price of ₹
12.80 is used
Solution:
(i)
Carrying Cost Storage cost = 2%
= Interest Rate = 12%
Obsolescence Rate = 6%
Total = 20%
C= 20% of 20
= 4 per unit per annum.

2𝐴𝑂 2∗5000∗16
EOQ = √ =√ = √40000 = 200 units.
𝐶 4

Total variable cost:

Purchase price of 5000 units @ 20 per unit =1,00,000
5000
Ordering Cost = 200 = 25 orders @ 16 = 400

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 200
Carrying cost of average inventory = = 100 units @ 4 = 400
2
Total variable cost = 1,00,800

(ii) If an incorrect price of 12.80 is used :

C = 20% of 12.80 = 2.56 per unit per annum

2∗5000∗16
E.O.Q = √ = 250 units
2.56

Total variable cost:

Purchase price of 5000 units @12.80 per unit = 64,000
5000
Ordering Cost = 250 = 25 orders @ 16 = 320
250
Carrying cost of average inventory = = 125 units @ 2.56 = 320
2
Total variable cost = 64,640

Question 3.
SHRI XYZ & CO. which manufactures a product ‘Ever Young’, provides you the following
information:

Monthly demand of ‘Ever Young’ = 900 units

Cost of Placing an order = 75
Carrying Cost per unit p.m. = 2%
Cost of Input to be purchase = 50 per kg.
Output per kg. of Input = 1.5 units

Required:
What percentage of discount in the price of input should be negotiated if the company
proposes to rationalize placements of orders on monthly basis?
Suppose the company followed the policy of economic order quantity and at the end of the
year, it was found that the cost of placing an order was 108 instead of 75 and all other
estimates were correct. What is the difference in cost on account of this error?
Solution:
(i) Carrying Cost per unit p.a. (C) = 2% × 12 × ₹ 50
= ₹ 12

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 Annual Usage (A) = (900 × 12)/1.5
= 7200 kg.

2AO 2×7200×75
EOQ = √ =√ = 300 Kg.
C 12
Total Cost when order quantity is 300 kg.
= Ordering Cost + Carrying Cost + Purchase Cost

7200 1
= ( 300 × ₹75) + (2 × 300 × ₹12) + (7200 × ₹50)

= 1,800 + 1,800 + ₹3,60,000

= ₹3,63,600

Suppose new negotiated purchase price is X, carrying cost will be 24X

Now, Total Cost when order quantity is 600 kg. will be –

7200 1
=( 300 × ₹75) + (2 × 600 × 0.24𝑋) + (7200X)

=900 + 72X + 7200X

= ₹900 + 7272X
In order to rationalize the placements of orders on monthly basis, the above cost should be
equal to total cost when order size is of economic order quantity.
Thus, ₹900+7272X = ₹3,63,600
7272X = ₹3,63,600 - ₹900
X = ₹3,62,700/7272
= ₹49.88 (approx...)
Discount Desired = ₹50 - ₹49.88 = ₹0.12
% of Discount to be negotiated = ₹ 0.12/50 × 100 = 0.24%

2×7200×108
(ii) Revised EOQ = √ = 360 Units
12

(a) Revised Total Ordering and Carrying Cost

7200 1
= ( 360 × ₹108) + (2 × 360 × ₹12)

= ₹2,160 + ₹2,160 = ₹4,320

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 (b) Total Ordering and Carrying Cost at actual economic order size of 300 and correct
ordering cost of ₹108
7200 1
= ( 300 × ₹108) + (2 × 300 × ₹12) = ₹2,592 + ₹1,800 = ₹4,392

(c) Difference in the relevant cost on account of wrong estimation of ordering cost [B-A]
= ₹4,392 - ₹4,320 = ₹72.

Question 4.
The complete Gardener is deciding on the economic order quantity for two brands of lawn
fertilizer. Super Grow and Nature’s Own. The following information is collected:

Fertilize
Super r Nature’s
Annual demand Grow
2,000 Own
1,280
Relevant ordering cost per purchase ₹ bags
1,200 ₹ bags
1,400
order
Annual relevant carrying cost per bag ₹ 480 ₹ 560

Required:
(i) Compute EOQ for Super Grow and Nature’sown.
(ii) For the EOQ, what is the sum of the total annual relevant ordering costs and total
annual relevant carrying costs for Super Grow and Nature’sown?

(iii) For the EOQ, compute the number of deliveries per year for Super Grow and
Nature’sown.

Solution:

EOQ = 2AO

C
Where,
A = Annual Demand
O = Ordering cost per order
C = Inventory carrying cost per unit per annum
(i) Calculation of EOQ:

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 Super Grow Nature’s own
2×2,000×1,200 2×1,280×1,400
EOQ= EOQ=
480 560
= 10,000 or 100bags = 6,400 or 80bags

(ii)Total annual relevant cost = Total annual relevant ordering costs + Total annual
relevant carryingcost
Super Grow Nature’s own
= (2,000/100 × ₹1,200) + (½ × 100 = (1,280/80 × ₹1,400) + (½ × 80 bags
bags × ₹480) × ₹ 560)
= ₹ 24,000 + ₹ 24,000 = ₹ 48,000 = ₹ 22,400 + ₹ 22,400 = ₹ 44,800

(iii)Number of deliveries for Super Grow and Nature’s own fertilizer per year
Annaul Demand for fertilizers bags
=
EOQ
Super Grow Nature’s own
2,000 bags 1,280bags
= = 20 orders = = 16 orders.
100 bags 80 bags

Question 5.
ZED Company supplies plastic crockery to fast food restaurants in metropolitan city.
One of its products is a special bowl, disposable after initial use, for serving soups to its
customers. Bowls are sold in pack 10 pieces at a price of ₹ 50 per pack.
The demand for plastic bowl has been forecasted at a fairly steady rate of 40,000 packs
every year. The company purchases the bowl direct from manufacturer at ₹ 40 per pack
within a three days lead time. The ordering and related cost is ₹ 8 per order. The storage
cost is 10%per annum of average inventory investment.
Required:
(i) Calculate Economic OrderQuantity.
(ii) Calculate number of orders needed every year.
(iii) Calculate the total cost of ordering and storage bowls for the year.

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(iv) Determine when should the next order to be placed. (Assuming that the
company does maintain a safety stock and that the present inventory level is 333
packs with a year of 360 workingdays.)

Solution:
(i) Economic OrderQuantity

2 A O 2*40,000packs *₹8
EOQ = = = 400packs.
Ci ₹40*10%

(ii) Number of orders per year

Annual requirements
E.O.Q
40,000 Packs
= = 100 orders a year
400 Packs

(iii) Ordering and storagecosts

(₹)

Ordering costs :– 100 orders ×₹8.00 800

Storage cost :– ½ (400 packs × 10% of ₹40) 800
Total cost of ordering & storage 1,600
(iv) Timing of nextorder
(a) Day’s requirement served by eachcorder.
No.of working days 360
Number of days requirements = = = 3.6 days supply
No.of order in a year 100

This implies that each order of 400 packs supplies for requirements of 3.6 days only.

(b) Days requirements covered by inventory

Units in Inventory
= × (Day’s requirement served by an order)
EOQ
333 Packs
=400 Packs × 3.6 Days

= 3 days requirement
(c) Time interval for placing next order

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Inventory left for day’s requirement – Lead time of delivery 3 days
= 3 days– 3 days

= 0days
This means that next order for the replenishment of supplies has to be placed
immediately.

Question 6.
The following information relating to a type of Raw material is
available: Annualdemand 2,000units

Unitprice ₹20.00
Ordering costperorder ₹20.00
Storagecost 2%p.a.
Interestrate 8%p.a.
Leadtime half-month
Calculate economic order quantity and total annual inventory cost of the raw material.
Solution:

2× Annual demand × Cost per

EOQ=
order

Storage cost₹20
22,000units per unit per
80,000
= annum =√ = 200Units
₹ 20 (2 8) % 2

Total Annual Inventory Cost =

Purchasing cost of 2,000 units @ ₹20perunit = ₹40,000
2,000 Units
Ordering Cost ( 200 Units × ₹20) = ₹ 200
Carrying Cost of Inventory ½ (200 Units ×₹20×10%) = ₹ 200
₹ 40,400

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Question 7.
An engineering company consumes 50,000 units of a component per year. The ordering,
receiving and handling costs are 3 per order while trucking costs are 12 per order. Further
details are as under:

Interest 0.06 per unit per year.

Deterioration cost 0.004 per unit per annum.
Storage cost 1,000 per annum for 50,000 units, calculate the EOQ.
Solution:
Buying cost per order 3.00
ADD: Trucking 12.00
Total Buying cost per order 15.00

Storage ( 1,000/50,000) 0.020

Deterioration 0.004
Interest 0.060
Total Carrying cost per unit p.a 0.084

We know that:

𝟐𝑨𝑶
EOQ = √ 𝑪

𝟐∗𝟓𝟎𝟎𝟎𝟎∗𝟏𝟓
=√ 𝟎.084

= 4226 units

Question 8. 8 Marks
The Stock Control Policy of a company is that each stock is ordered twice a year. The
quantum of each order being one-half of the years forecast demand.
The Materials Manager, however wishes to introduce a policy in which for each item of
stock, Re-Order Levels and EOQ is calculated. For one of the items X, the following
information is available
Forecast annual demand 3,600 Units
Cost per Unit ₹100

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Cost of placing an order ₹40
Stock holding cost 20% of Average Stock Value
Lead Time 1 month
It is estimated by the materials manager that for item X, a Buffer Stock of additional 100
Units should be provided to cover fluctuations in demand.
If the new policy is adopted, calculate for Stock Item X –
1. Re-Order Level that should be set by the Material Manager.
2. Anticipated Reduction in the value of the average stock investment.
3. Anticipated Reduction in the Total Inventory Costs in the first and subsequent years.
Solution:

𝟐𝑨𝑶
1. EOQ = √ 𝑪

Where,
A=Annual Requirement of Raw Materials= 3,600 units (given)
O=Ordering Cost= ₹40 per Order (given)
C=Carrying Cost per unit per annum = ₹100×20% = ₹20 p.u. p.a.

On Substitution, EOQ = 120 Units.

2. Re-Order Level = Safety Stock + Lead Time Consumption (1 Month)

= 100Units + (3,600×1/12)
= 400 Units
3. EOQ vs Half-Yearly Purchase Policy
Particulars EOQ Existing Policy (half-yearly)

(a) Quantity Ordered every time (Q) 120 Units 3600/2 = 1,800 Units
(b) Number of Orders p.a. 3600/120 = 30 Orders (Half-Yearly) = 2 Orders
(c)Buying Costs p.a. at ₹40 30×₹40 = ₹1,200 2×₹40 = ₹80
(d) Average Inventory = ½ of (a) Safety Stock+1/2EOQ ½ × ₹1,800 = ₹900 Units
= 100+60=160 Units
(e) Value of Avg. ₹16,000 ₹90,000
Inventory=(d×₹100)
(f) Carrying Cost p.a. at 20% of (e) ₹3,200 ₹18,000

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 (g) Associated Cost p.a. = (c+ f) ₹4,400 ₹18,080

Anticipated reduction in value of average stock Investment = ₹90,000 – ₹16,000

= ₹74,000.
Anticipatory reduction in total inventory-related costs = ₹18,080 – ₹4,400
= ₹13,680
However, in the first year, Safety Stock of 100 Units is to be purchased at cost of ₹10,000
(100 Units×₹100). So, while the saving would be of ₹13,680, the cost reduction in the
system would be only ₹3,680. In subsequent years, however, the cost reduction will be
₹13,680.

Question 9.
X Ltd. Is committed to supply 24,000 bearings per annum to Y Ltd. On steady basis. It is
estimated that it costs 10 paise as inventory holding cost per bearing per month and that
the set-up cost per run of bearing manufacture is 324.

(a) What would be the optimum run size for bearing manufacture?
(b) Assuming that the company has a policy of manufacturing 6,000 bearing per run, how
much extra costs the company would be incurring as compared to the optimum run
suggested in (a) above?
(c) What is the minimum inventory holding cost?
Solution:
(a) Optimum Production run (batch) size =
𝟐𝑨𝑶
EOQ = √ 𝑪

𝟐∗𝟐𝟒𝟎𝟎𝟎∗𝟑𝟐𝟒
=√ 𝟎.𝟏𝟎∗𝟏𝟐

= 3600 bearing
(b) For finding out the extra inventory cost, it is necessary to work out the total cost when
production run sizes are 3600 & 6000.
Total Cost = Total set-up + Total Carrying Cost

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 Total set-up cost = production run orders * cost per production run
24000
= 3600 * 324 = 2,160
24000
Total set-up cost when Q is 6000 = * 324 = 1296
6000

Total carrying cost when Q is 3600 = ½ * Q * carrying cost p.a

= ½ * 3600* 0.10*12
= 2160
Total carrying cost when Q is 6000 = ½ * 6000* 0.10*12
= 3600

Total cost when Q is 6000 = 1296+3600 = 4896

Total cost when Q is 3600 = 2160+2160 = 4320
Extra cost = 4896- 4320 = 576

(c) Minimum Inventory holding cost = ½ * Q * carrying cost p.a

= ½ * 3600 * 0.10 * 12
= 2160.

Question 10.
The annual cost of Material X is 3.60 per unit and its Total Carrying Cost is 9,000 per
annum. What would be the Economic Order Quantity for Material X, If there is no Safety
Stock of Material X?

Solution:
Average Inventory * Carrying cost per unit p.a = 9000
½ of EOQ * 3.6 = 9000

9000∗2
EOQ = 3.6
= 5000 units

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