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Sir, do we include the cost of finance which I assume is the overdraft interest in the Holding cost?
Kaplan text has stated an example wher then finance cost is used in overall cost of holding per unit
[Example]
Monthly demand is 10,00p for a product. The purchase price is $10/unit and the company’s cost of finance is 15% pa. Warehouse storage costs is $2/unit. This supplier charges $200 per order for delivery.Calculate the EOQ.
[Answer]
This is how Kaplan text calculate the EOQSquareroot 2 x 200 x 10,000 / (10 x 15%) + 2
EOQ = 3703
Now as you see the finance cost taken on the purchase price along with holding cost per unit which I was suprised to see. Could you please tell me why did they calculate in such way??
As I do explain in my free lectures on this, the most important cost of holding inventory is the interest cost of the money tied up in inventory.
Holding one unit of average inventory for one year means that $10 cash is tied up in inventory that is losing them interest at 15% per year. Therefore a holding cost of 15% x $10 p.a. (in addition to any other holding costs that there may be).
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- ☆☆
So we always add the finance cost to the Holding cost just like you also did in example 1 of your lecture video because we are losing interest on cash because our cash being tied in inventory (as you said)
Sir, there is a question called Dusty Co requirement (a) (ii) (September/December 2019) where it says “holding cost of component K, excluding finance costs, is $0.21 per unit per year.”.
So I have included the finance cost in the Holding cost & calculated the Total costs of inventory like this:
EOQ = square root 2 x 1500,000 x $252 / (0.21 x 1.03) = 59119
Ordering cost = 25.37 x 252 = $6,393
Holding cost = 29,559 x 0·2163 = $6,393Total inventory costs = $12786
Please correct me If I am wrong anywhere! Thank you 🙂
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