Total Acquisition Costs (1 of 2)

• Total Acquisition Cost: sum of all relevant annual

inventory costs
– Holding Costs: associated with storing and assuming
risk of having inventory

– Ordering Costs: associated with placing orders and

receiving supply

Learning Objective 7-4

7-1
 Total Acquisition Costs (2 of 2)
TAC = annual ordering cost + annual carrying cost
TAC = Co (D/Q) + UCi * Q/2
N = D/Q
I = Q/2

Where:
N = orders per year I = average inventory level
D = annual demand Co= order cost
Q = order quantity U = unit cost
Ci = % carrying cost per year

Learning Objective 7-4

7-2
 Total Acquisition Costs—Example 7.4
If we need 3,000 units per year at a unit price of $20 and
we order 500 each time, at a cost of $500 per order, with
a carrying cost of 20 percent, what is the TAC?
N = D/Q = 3000/500 = 6 orders per year
I = Q/2 = 500/2 = 250 average inventory
TAC = ordering cost + carrying cost
= Co (D/Q) + (UCi )(Q/2)
= $50 (3000/500) + ($20 × 20%) × (500/2)
= $1,300
Where:
N = D/Q Q = 500 I = Q/2
U = $20 D = 3,000 Co = $50 Ci = 20%

Learning Objective 7-4

7-3
 Total Acquisition Costs—Example 7.5
If we need 3,000 units per year at a unit price of $20 and
we order 200 each time, at a cost of $500 per order, with
a carrying cost of 20 percent, what is the TAC?
N = D/Q = 3000/200 = 15 orders per year
I = Q/2 = 200/2 = 100 average inventory
TAC = ordering cost + carrying cost
= Co(D/Q) + (UCi)(Q/2)
= $50(3000/200) + ($20 × 20%) × (200/2)
= $1,150
Where:
N = D/Q Q = 200 I = Q/2
U = $20 D = 3,000 Co = $50 Ci = 20%

Learning Objective 7-4

7-4
 Total Acquisition Costs Comparison
Figure 7-1 Trexoid Inventory Saw-Tooth Diagram: Order
Quantity 500

Figure 7-2 Trexoid Inventory Saw-Tooth Diagram: Order

Quantity 200

Learning Objective 7-4

7-5
 Economic Order Quantity (EOQ) (1 of 4)

• Economic Order Quantity (EOQ): minimizes

total acquisition costs; points at which ordering
costs and carrying costs are equal

Learning Objective 7-4

7-6
 Economic Order Quantity (EOQ) (2 of 4)
Example 7-6
If we need 3,000 units per year at a unit price of $20, at a
cost of $50 per order with a carrying cost of 20 percent,
what is lowest TAC order quantity?

Learning Objective 7-4

7-7
 Economic Order Quantity (EOQ) (3 of 4)
Example 7-6
If we need 3,000 units per year at a unit price of $20, at a
cost of $50 per order with a carrying cost of 20 percent,
what is lowest TAC order quantity?

3000/274 = 10.948, rounded to 11.

Average inventory will be 137 units.

TAC = Order cost + Inventory carrying cost = 11($50)

+ 137($20)(.2) = $550 + $548 = $1,098

Learning Objective 7-4

7-8
 Economic Order Quantity (EOQ) (4 of 4)
Figure 7-3 EOQ Cost Trade-Offs

Learning Objective 7-4

7-9
 Reorder Point (1 of 2)
• Reorder Point: minimum level of inventory that triggers
a replenishment

• When to order:

Learning Objective 7-4

7-10
 Reorder Point (2 of 2)
Example 7-7
If you use 10 units per day, and the lead time for
resupply is 9 days, how low can your inventory get
before placing a new order?

Learning Objective 7-4

7-11
 EOQ Extensions

Assumptions underlying EOQ:

• No quantity discounts

• No lot size restrictions

• No partial deliveries

• No variability

• No product interactions

Learning Objective 7-4

7-12
 Quantity Discounts
Determining best price break quantity:
• Identify price breaks/lot size restrictions
• Calculate EOQ for each price/lot size
• Evaluate viability of each option
• Calculate TAC for each option
• Select best TAC option

Learning Objective 7-4

7-13
 Total Acquisition Costs

Learning Objective 7-4

7-14
 Total Acquisition Costs—Without Price
Discount
Example 7-8
If we need 3,000 units per year at a unit price of $20, at a cost
of $50 per order with a carrying cost of 20 percent, what is TAC
with a Q=1,000?
Where:

Learning Objective 7-4

7-15
 Production Order Quantity (1 of 2)
Production Order Quantity: most economical order
quantity when units become available at rate produced

Learning Objective 7-4

7-16
 Production Order Quantity (2 of 2)

Learning Objective 7-4

7-17
 Production Order Quantity—Example 7-9
Consider the manufacturer of the Trexoid video games you have been
ordering for your store. The manufacturer expects annual demand from
all retailers to be 500,000 units of Trexoid games. It receives orders from
retailers for, on average, 2,000 units per day (250 days per year). To
change from production of another game to production of Trexoid
requires a setup cost of $2,000. Once production of Trexoid units begins,
it can produce 5,000 units per day. The cost to produce a unit of Trexoid
is $10. Finally, the manufacturer has determined that its inventory
carrying cost is 25 percent annually. The fundamental question to answer
is how many units of Trexoid should be ordered in each production run? It
is also useful to know the length of the production run in days.

Qp= production order quantity (the same concept as EOQ)

D = annual demand = 500,000
Co= setup cost (the same concept as ordering cost in EOQ) = $2,000
Ci = annual inventory carrying cost percentage = 25%
U = unit cost = $10
d = daily rate of customer demand = 2,000
p = daily rate of production = 5,000

Learning Objective 7-4

7-18