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Dear Sir,
I have been practising from one the kit I came across this question which the answer is 40,000. I may sound stupid but I am baffled at how the answer came by. Here is the mini question I would like help on.
A company uses 120,000 units of Material X each year, which costs $3 for each unit before discount. The costs of making an order are $605 for each order.
The annual cost of holding inventory is 10% of the purchase cost. The supplier will offer a price discount of $0.10 per unit for orders of 25,000 up to 40,000 units, and a discount of $0.20 per unit for orders of 40,000 units or more.
What is the order quantity that will minimise total costs? Answer 40,000
what the answer means is the range above 40,000 is the range at which total costs will be minimized
madihaf92: Please do not answer in this forum – it is Ask the Tutor Forum and you are not the tutor. (Although please do help people in the other F9 forum)
Also, what you have written is not correct. The answer does not mean a range – ordering exactly 40,000 units each time will give the minimum cost. Ordering more than 40,000 will cost more.
vipulv: First you need to calculate the EOQ ignoring the discount, using the formula.
The EOQ is 22,000 units.
Then you need to calculate the total inventory costs at the EOQ.Without any discounts this would be the order quantity that minimised inventory costs – any other order level would cost more.
However because higher order levels mean they get it discount, it could be worthwhile ordering bigger quantities, even though the inventory costs will be higher.So you then need to calculate the total costs at each of the levels when they first get a discount. In this case ordering 25,000 and ordering 40,000 each time.
Whichever is the cheapest of those three (22,000, 25,000 and 40,000) is the best. (Any other order quantity is bound to be more expensive.
For a full explanation with examples you need to watch the free lectures – I cannot type them all out here.
Because this is revision of Paper F2, the lectures on inventory control are in the Paper F2 section of the website.FANTASTIC SIR 🙂 After going through the Inventory on F2 I got it I see exactly how 40,000 we chose as this is cheapest:
22,000 = Total cost 366,800
25,000 = 354,529
40,000 = 343,415
So choose 40,000 🙂
Your a star! 🙂
Sir, in the above answer for Q=22000, Total cost = $366800?? I get Total Cost = $366600. Am I doing it wrong?
For Q=22000,
Purchase Cost = 120000*$3 = $360000
Order Cost = (120000/22000) * 605 = $3300
Holding Cost = (10% of $3) * Average Inventory = $0.3 * (22000/2) = $3300Total Costs(Q:22000) = $366600
@sampat54 said:
Sir, in the above answer for Q=22000, Total cost = $366800?? I get Total Cost = $366600. Am I doing it wrong?For Q=22000,
Purchase Cost = 120000*$3 = $360000
Order Cost = (120000/22000) * 605 = $3300
Holding Cost = (10% of $3) * Average Inventory = $0.3 * (22000/2) = $3300Total Costs(Q:22000) = $366600
Hi Apology my typing you are correct it is 366 600
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