Example of EOQ Assumptions

ABC Ltd requires 2,000 units of a component in its manufacturing method in the coming year that costs of Sh.50 each. The items are obtainable locally and the lead-time in one week.  Each order costs of Sh.50 to prepare and process whereas the holding cost is of Shs.15 per unit per year for storage plus 10 percent opportunity cost of capital.

Required

a) How many units must be ordered each time an order is located to minimize inventory costs?

b) What is the reorder level?

c) How many orders will be located per year?

d) Find out the total relevant costs.

Suggested Solution:

a)

Where      :  D = 2,000 units

                   C_o = Sh.50

                   C_n = Sh.15 + 10% x 50 = Sh.20

                   L = 7 days

b) R  =       DL/360

         =       (2,000 * 7)/360

          =       39 units

c) Number of orders = D/Q       

                               = 2,000/100

                               = 20 orders

d) TC     =       ½QCn + (D/Q) * C₀

              =       ½(100)(20) +  (2,000/100) * 50

              =       1,000 + 1,000

              =       Sh.2,000

Beneath the basic EOQ Model the inventory is permitted to fall to zero just before another order is acknowledged.