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Dear John,
I would like to clarify a doubt regarding EOQ w/ discounts.
In the example given in the free lecture notes (Chapter 4, Example 3), the discounts given were calculated into the holding costs and the purchase cost. However, in an example given in the BPP textbook, the discounts given were calculated into the purchase cost only.
Here is the BPP example for your reference:
Firm faces regular demand of 150 units per month. The purchase cost per unit is $25. Each order costs $32 and the annual holding cost is $4.50 per unit. Discount of 2% is given on orders of 300 and over.The total cost is $44,967 for a discount of 2% given. (see workings below)
Order cost = (150 x 12)/300 x $32 = $192
Holding cost = 300/2 x $4.50 = $675 (DISCOUNT NOT ACCOUNTED)
Purchase cost = (150 x 12) x $25 x 98% = $44,100 (Discount accounted)
Total cost = $44,967Thus, I would like to ask you if we are supposed to account the discount given into BOTH the holding cost & purchase cost (like what we did in the free lecture notes) or do we just account it into the purchase cost?
Thank you in advance, appreciate your help!
If the holding cost is given in $’s then it is not affected by there being a discount on the purchase price.
If the holding cost is given as a %, then if the purchase price changes then so does the holding cost.
Think about it. Some holding costs just relate to using space in the warehouse, and the space taken will be the same whether or not there is a discount.
However, the most important holding cost is the cost of the money tied up in inventory, and because that is the interest cost as a %, then that will change if the purchase price is lower because of the discount.
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