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ACCA FM · Guided practice (Show me how)

Chapter 4: Management of working capital (2) – Inventory

Economic order quantity and quantity discounts

Rafael has demand for 40,000 desks p.a. The purchase price of each desk is $25. There are ordering costs of $20 for each order placed. Inventory holding costs amount to 10% p.a. of inventory value.

(a) Calculate the inventory costs p.a. for order quantities of 500, 750, 1,000 and 1,250 units, and identify the cheapest.

(b) Use the EOQ formula to calculate the economic order quantity, and the total inventory costs for this order quantity. EOQ = square root of (2 x Co x D / CH), where Co = fixed cost per order, D = annual demand and CH = the stockholding cost per unit per annum.

(c) The supplier now offers discounts on the purchase price: 0% for orders below 5,000 units; 1% for orders of 5,000 to below 10,000 units; 1.5% for orders of 10,000 units or over. Calculate the total annual cost, including the purchase cost, at each discount level, and so find the best order quantity.

  1. (a) Cost of four order quantities

    Calculate Rafael's inventory holding cost per desk and annual inventory costs at the specified order quantities, and identify the lowest-cost policy.

  2. (b) The EOQ formula

    Calculate Rafael's economic order quantity and total annual inventory cost at that quantity.

  3. (c) Quantity discounts

    Calculate Rafael's total annual cost at each quantity discount level and identify the lowest-cost order policy.

Opening this exercise…