INVENTORY MODEL :-

EOQ (ECONOMIC ORDER QUANTITY)

Presented By
Dr. Dileep kumar singh
Asst. Professor
Institute of Management Studies
Mahatrma Gandhi Kashi Vidyapith
varanasi
 Inventory models
 Help to decide
 How much to order
 When to order
 Basic EOQ model
 Basic EOQ model
 Assumptions
 Known and constant demand
 Known and constant lead time
 Instantaneous receipt of material
 No quantity discounts
 Only order (setup) cost and holding cost
 No stockouts
 Basic EOQ model

 Receive an order
 Use the inventory at a constant rate
 Reorder same amount
 Instantaneously receive the order
 Economic Order
Quantity
On-hand inventory (units)

Time
 Economic Order
Quantity
On-hand inventory (units)

Time
 Economic Order
Quantity
Receive
order
On-hand inventory (units)

Time
 Economic Order
Quantity
Receive
order
On-hand inventory (units)

1 cycle
Time
 Economic Order
Quantity
Receive
order
On-hand inventory (units)

1 cycle
Time
 Economic Order
Quantity
Receive Inventory depletion
order (demand rate)
On-hand inventory (units)

1 cycle
Time
 Economic Order
Quantity
Receive Inventory depletion
order (demand rate)
On-hand inventory (units)

1 cycle
Time
 Economic Order
Quantity
Receive Inventory depletion
order (demand rate)
On-hand inventory (units)

Q Average
— cycle
2
inventory

1 cycle
Time
Total Cost = Holding Cost + Order Cost
Total Cost = Holding Cost +
Order Cost
Annual cost (dollars)

Lot Size (Q)

Total Cost = Holding Cost + Order Cost
Annual cost (dollars)

Holding cost (HC)

Lot Size (Q)

 Why Holding Costs Increase
 More units must be stored if more are ordered

Purchase Order Purchase Order

Description Qty. Description Qty.
Microwave 1 Microwave 1000
Order quantity Order quantity
Total Cost = Holding Cost + Order Cost
Annual cost (dollars)

Holding cost (HC)

Ordering cost (OC)

Lot Size (Q)

 Why Order Costs Decrease
 If we order more when we place an Order cost $10
order, then we order fewer times over
the year. Purchase Order
 Example: You expect to order 10 Description Qty.
microwave ovens over a year for a Microwave 1
retail store like Sears. It cost $10 to
place an order.
 If you order 1 microwave, how many
orders will you place over the year? Order Cost $10
what is the ordering cost? What is
Purchase Order
the ordering cost per microwave?
Description Qty.
 If you order 10 microwaves, how Microwave 10
many orders will you place over the
year? What is the ordering cost? What
is the ordering cost per microwave?
Total Cost = Holding Cost + Order Cost

Total cost = HC + OC
Annual cost (dollars)

Holding cost (HC)

Ordering cost (OC)

Lot Size (Q)

 Gift Shop
 A museum of natural history is having
problems managing their inventories. Low
inventory turnover is squeezing profit
margins and causing cash-flow problems.
 A Class A item, a birdfeeder is also a top-
selling item.
 Sales: 18 units/week
 Purchase cost: $60
 Order cost: $45
 Annual holding cost: 25% of purchase cost
 52-week year
 Management has been ordering in lots of
390 units.
 What is the annual cost of the
current policy?
 Q – order quantity Q

 TC – Total cost
 Annual Time

 Monthly
 ??
 Holding Cost
AnnualHoldingCost 
( AveInventory )( HoldingCost / unit / year )

Q
AnnualHoldingCost    H
2
 Holding cost
3000 —
Annual cost (dollars)

2000 — Q
Holding cost = (H)
2

1000 —

| | | | | | | |
0— 50 100 150 200 250 300 350 400

Lot Size (Q)

 Ordering cost

AnnualDemand
AnnualOrderCost  (OrderCost)
OrderQuantity

D
AnnualOrderCost  S
Q
Holding & Ordering
Cost
3000 —
Annual cost (dollars)

2000 — Q
Holding cost = (H)
2

1000 — D
Ordering cost = (S)
Q

| | | | | | | |
0— 50 100 150 200 250 300 350 400

Lot Size (Q)

 Total Cost
3000 — Q D
Annual cost (dollars)

Total cost = (H) + (S)

2 Q

2000 — Q
Holding cost = (H)
2

1000 — D
Ordering cost = (S)
Q

| | | | | | | |
0— 50 100 150 200 250 300 350 400

Lot Size (Q)

 Total cost:

TotalCost  TotalOrder Cost  TotalHoldi ngCost

D Q
TC  S  H
Q 2
 What is the annual cost of the current
policy?
D Q
D – Total demand TC  S  H
Q 2
Q – Order quantity

S – Setup/order cost

H – Holding cost
 What is the annual cost of the current
policy?
D Q
D – Total demand
936/year
TC  S  H
Q 2
Q – Order quantity 936 390
390/order TC  45  15
390 2
S – Setup/order cost
$45/order TC  108  2925
H – Holding cost
TC  3033
= 0.25*60
Total Cost for Q = 390
Current
cost

3000 — Q D
Annual cost (dollars)

Total cost = (H) + (S)

2 Q

2000 — Q
Holding cost = (H)
2

1000 — D
Ordering cost = (S)
Q

| | | | | | | |
0— 50 100 150 200 250 300 350 400
Current
Lot Size (Q)
Q
Can the gift shop do better?
Current
cost

3000 — Q D
Annual cost (dollars)

Total cost = (H) + (S)

2 Q

2000 — Q
Holding cost = (H)
2

1000 — D
Ordering cost = (S)
Q

| | | | | | | |
0— 50 100 150 200 250 300 350 400
Current
Lot Size (Q)
Q
Economic Order Quantity – Q*

3000 —
Annual cost (dollars)

2000 —

1000 —
Setup cost = Holding Cost
| | | | | | | |
0— 50 100 150 200 250 300 350 400

Q* Lot Size (Q)

Economic Order Quantity (EOQ) – Q*

2 DS
Q* 
H

2(936)(45)
Q*   74.94  75units / order
15
Total Cost of Economic Order
Quantity (EOQ) – Q*
D Q*
TC  S H
Q* 2
936 75
TC  45  15
75 2
When Q = 390
TC  1124.10 TC  3033
 When to order?
 Reorder point (ROP)
 Lead time – amount of time from order placement
to receipt of goods
 Lead time demand – the demand the occurs during
the lead time
 Reorder point
Order
received
On-hand inventory

OH
 Reorder point
Order
received
On-hand inventory

OH

TBO Time between orders

 Reorder point
Order
received
On-hand inventory

OH

L
TBO
Lead time
 Reorder point
Order
received
On-hand inventory

OH

R
Order
placed

L
TBO
 Gift shop reorder point

 Demand: 18 birdfeeders/week

 Lead time: 2 weeks

 Lead time demand: 36 birdfeeders

 ROP: 36 birdfeeders
 Gift shop order policy
 Place order when the on-hand inventory is 36
birdfeeders.
 Order 75 birdfeeders
 Order received in 2 weeks
 Place next order when the on-hand inventory
is 36 birdfeeders
Gift shop order policy
Order
received
On-hand inventory

75

OH

36
Order
placed

2 wks
 Distribution Game
 What is the EOQ for
the central
warehouse in the
distribution game?
 Order cost: S= $200

 Holding cost: H = $14.70/unit/year

 Demand: D= 2190
 Distribution Game
2 DS
Q* 
H

2(2190)(200)
Q* 
14.7

Q*  244.1  244units