Basic EOQ Model

Assumption
• Seasonal fluctuation in demand are ruled out
• Zero lead time
• Cost of placing an order and receiving are same and independent of the units
ordered
• Annual cost of carrying the inventory is constant
• Total inventory cost = Ordering cost + carrying cost
Three Approaches
1. Trial and Error method
2. Order-formula approach
3. Graphical approach
Trial and Error method

If the total needs of inventory for a form are known, the firm has different
alternatives to purchase its inventories. It can buy its total needs in a single
order at the beginning of the year or the inventories may be purchased in small
orders periodically. If the purchase are made in one order, the average
inventory holdings will be relatively large whereas they will be relatively small
when the acquisition of inventory is in small lots. High average inventory would
involve high carrying cost and low average inventory holdings are associated
with high ordering costs. According to this method, the carrying and ordering
costs for different sizes of orders to purchase inventories are computed and the
order size with the lowest total cost of inventory is the economic order
quantity.
For example
Let Annual requirement (C)=1200 units Carrying cost (I) = Rs.1
Ordering cost (O) =Rs.37.5
Order size (Q) 1200 600 400 300 240 200 150 120 100

Average 600 300 200 150 120 100 75 60 50

inventory Q/2
No. of orders 1 2 3 4 5 6 8 10 12
C/Q
Annual carrying 600 300 200 150 120 100 75 60 50
cost I* Q/2
Annual ordering 37.5 75 112.5 150 187.5 225 300 375 450
cost O*C/Q
Total annual 637.5 375 312.5 300 307.5 325 375 435 500
cost

Order-formula approach
With the help of following formula, the economic order quantity can be calculated.

For example
1
EOQ = (2 ∗ 1200 ∗ 37.5/1) = 300 units
2
 Graphical approach
Under this method, the carrying cost, ordering cost and total cost are shown on
graph. It is based on the principle that the total carrying cost increases as the order
size increases. However, the ordering cost decreases if the order size increases.
The point at which the ordering cost and carrying cost intersects each other, total
cost is minimum.

SPECIAL INVENTORY MODEL

1. Non – Instantaneous replenishment
2. Quantity Discount
3. One – period decision
Non – Instantaneous replenishment
• This occurs when the production rate is not instantaneous and
inventory is replenished gradually, rather than in lots.
• If an item is being produced internally rather than purchased, finished
units may be used or sold as soon as they are completed, without
waiting until a full lot is completed.
• Production rate, p, exceeds the demand rate, d.
• Cycle inventory accumulates faster than demand occurs
• A buildup of p – d units occurs per time period, continuing until the lot
size, Q, has been produce

Cycle inventory is no longer Q/2, as it was with the basic EOQ method;
instead, it is the maximum cycle inventory (Imax / 2)
 Q
Imax = (p − d)
p

Total annual cost (C) = Annual holding cost + annual ordering or setup cost

𝑄 𝑝−𝑑 𝐷
𝐶= ( )𝐻 + 𝑆
2 𝑝 𝑄

D = annual demand
d = daily demand
p = production rate
S = setup costs
Q = ELS
H= unit holding cost

Economic production lot size (ELS) is the optimal lot size in a situation in
which replenishment is not instantaneous.
2𝐷𝑆 𝑝
𝐸𝐿𝑆 = √ ×√
𝐻 𝑝−𝑑
Example 1
The manager of a chemical plant must determine the following for a
particular chemical:
1. Determine the economic production lot size (ELS).
2. Determine the total annual setup and inventory holding costs.
3. Determine the TBO, or cycle length, for the ELS.
4. Determine the production time per lot.
5. What are the advantages of reducing the setup time by 10 percent ?

Demand = 30 barrels/day Setup cost = $200 Production rate = 190 barrels/day

Annual holding cost = $0.21/barrel Annual demand = 10,500 barrels Plant operates
350 days/year
 2𝐷𝑆 𝑝
𝐸𝐿𝑆 = √ ×√
𝐻 𝑝−𝑑

2(10500)($200) 190
𝐸𝐿𝑆 = √ ×√
$0.21 190 − 30

=4873.4 barrels
Finding total annual cost

𝑄 𝑝−𝑑 𝐷
𝐶= ( )𝐻 + 𝑆
2 𝑝 𝑄
4,873.4  190  30  10,500
  $0.21  $200
2  190  4,873.4

 $430.91 $430.91  $861.82

Production time = 4873.4 190 Production Production time = 25.6, or 26 days

E
Advantage of Reducing Setup Time OM Explorer Solver for the Economic
Production Lot Size Showing the effect of a 10 Percent Reduction in setup
cost.

Quantity Discount
If discount increases with the order quantity, then the price of inventory is no
more constant. So in this case a deferent method for inventory management must
be adopted.
One – period decision
If a newspaper seller does not buy enough papers to resell on the street corner,
sales opportunity is lost. If the seller buys too many, the overage cannot be sold
because nobody wants yesterday’s newspaper. This is also applicable for fashion
goods, seasonal goods and due to change in technology.