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    • Profile photo of John Moffat says

      The discount only applies to the purchase price.

      It will affect the holding cost but only because the holding cost is a % of the purchase price in this question. If the purchase cost is lower then obviously the holding cost in this case will be lower.

      There is no reason at all why the order cost should be affected. If we are charged (say) $100 for delivery, then just because the purchase price is lower, it will not mean that the delivery cost is lower.

    • Profile photo of John Moffat says

      I do deal with this in the lecture.

      Think about the graph that I drew.

      The EOQ is where the total inventory costs are at a minimum. At any other level the total inventory costs will be higher.
      If we order 10,000 then it could be worth having the higher inventory costs because we will get the discount on the purchase price – the only way we can check is by costing out.

      However, if we ordered (say) 7,000, then the total inventory costs will be higher than at the EOQ. We will still be having to pay the same purchase price, so it cannot possibly be better that the EOQ.

      The best is always the cheaper of the EOQ and the levels at which we first get a discount. No other levels could possibly be better.

    • Profile photo of John Moffat says

      Usually in the exam (and in this question) the re-order cost is given as a fixed amount e.g. $20 per order. In this case we assume that it will remain at $20 per order whatever the size of the order.

      In practice, it could change with the size of the order, but even then it would not be relevant.

      Suppose the reorder cost was a fixed $20 per order plus $0.10 per unit ordered. Obviously as the number of orders changes the total of the $20’s will change over the year. With regard to the $0.10 per unit order, the cost of the individual order will indeed change with the number of units ordered. However, over the year we will still order the same number of units in total, and so over the year, the number of $0.10’s will stay fixed.

      So……although there is unlikely to be a variable order cost in the exam, we would still only consider the fixed cost per order in the formula and when dealing with discounts.

      I hope that makes sense :-)

  1. avatar says

    Hi Mr John Moffat

    Thank you for your lectures, they are helping me understand the subject better alongside Kaplan text books. Could you please help? I have done the order level at 10000 and am getting a different result to you?

    40000/10000 x 4 x 20 = 80
    10000/2 = 5000 x 2.4625 = 12312.50 + 80 = 12392.50
    40000 x 98.5 x 25 = 98500 000 + 12392.50 = $98 512 393

    I am not sure where my mistake is?

    Kindest regards

  2. avatar says

    Hi Sir, I am currently using this lecture for paper F9. My question is that there are two remaining lectures for paper F2 which are for EBQ Example 4&5 and Re-order Level. Do the last two lectures apply for paper F9 as well? Because in the course notes for F9, it stops at example 3 and then last page has something about just in time system and that’s about it for that chapter.

  3. avatar says

    I have understood that if the holding cost per unit is fixed, it will not be affected by the discount while calculating the total annual holding cost. But, in the BPP Practise & Revision Kit, there is the exercise below (Answers Bank 6.19 page 128)

    “A company uses an item of inventory as follows.
    Purchase price $25 per unit
    Annual demand 1,800 units
    Ordering cost $32
    Annual holding cost $4.50 per unit
    EOQ 160 units
    What is the minimum total cost assuming a discount of 2% given on orders of 300 and over?
    A $45,720.00
    B $44,953.50
    C $45,000.00
    D $44,967.00″

    I got $44,967.00 and chose D.

    But they chose B. They applied the discount in the total holding cost computation. Below are the details:

    “With a discount of 2% and an order quantity of 300 units, unit costs are as follows.
    Purchases $45,000 × 98% 44,100.00
    Holding costs (W1) 661.50
    Ordering costs (W2) 192.00
    Total annual costs 44,953.50
    Workings:
    (1) Holding costs = average inventory × holding cost for one unit of inventory for one year
    Average inventory = order quantity ÷ 2 = 300 ÷ 2 = 150 units
    Holding cost for one unit of inventory for one year = $4.50 × 98% = $4.41
    => holding costs = 150 units × $4.41 = $661.50
    (2) Ordering costs = number of orders × ordering costs per order ($32)
    Number of orders = Annual demand ÷ order quantity = 1,800 ÷ 300 = 6 orders
    => ordering cost = 6 orders × $32 = $192″

    Please help. I am confused.

  4. Profile photo of nari says

    i understand that the TOTAL cost per ANNUM is cheaper at 5,000 units, however when i first did it i chose 10,000 units because the cost per unit is cheaper at that amount…… at 10,000 its 99.73 while at 5,000 its 199.27.

      • avatar says

        I am having trouble answering this question can some kindly show me the calculation for this:

        A company uses uses item of inventory as follows.
        purchase price 25
        annual demand 1800
        ordering cost 32
        annual holding costs 4.50
        EOQ 160

        what is the minimum total costs assuming a discount of 2% given on orders of 300 and over?

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