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Hello John.
-The production manager has established the following information about a major inventory item.
Purchase price per unit $480
Annual demand 4000
Delivery Cost per order $10
Total number of orders per annum 1000
Annual storage costs per unit $2
Cost of capital 10% per annum.What is the economic order quantity for this inventory item?
1. The answer is 40 units.
2. The cost of ordering is calculated as follows: $2+10% of $480.
-Could explain the logic of calculating ordering cost? In this question, why $2 has not been used the ordering cost?The cost of ordering is not as you have written – the cost is $10.
It is the holding cost that is $2 (because the questions says that this is the storage cost) + 10% x $480 (because $480 is the cost per units, and 10% is the interest cost of money tied up in inventory).
I explain this in my free lectures on the management of inventory.
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