An economic enterprise requires 90,000 units of certain item annually. The cost per unit is Rs. 3. The cost per purchase order is Rs. 300 and the inventory carrying cost is Rs. 6 per unit per year. What is EOQ?
3000 units
Understanding the Economic Order Quantity (EOQ)
This problem asks us to calculate the Economic Order Quantity (EOQ) for an economic enterprise. The EOQ is a crucial concept in inventory management that helps determine the optimal order quantity to minimize the total inventory costs, which include ordering costs and holding costs.
What is EOQ?
The Economic Order Quantity (EOQ) is the ideal quantity of goods that a company should purchase to minimize inventory costs such as holding costs, shortage costs, and order costs. It is a model designed to find the most efficient inventory level.
EOQ Formula
The standard formula for calculating EOQ is:
Where:
- D = Annual Demand (in units)
- S = Ordering Cost per order
- H = Holding or Carrying Cost per unit per year
Note: The cost per unit (Rs. 3 in this case) is not directly used in the basic EOQ formula but is relevant for calculating the total cost of goods or other related metrics.
Applying the EOQ Formula: Step-by-Step Calculation
Let's identify the given values from the problem:
- Annual Demand (D) = 90,000 units
- Ordering Cost per order (S) = Rs. 300
- Inventory Carrying Cost per unit per year (H) = Rs. 6
Now, we substitute these values into the EOQ formula:
First, calculate the numerator:
Now, divide the numerator by the holding cost (H):
Finally, take the square root of the result:
The Economic Order Quantity is 3000 units.
Result
The calculated EOQ is 3000 units. This means that ordering 3000 units at a time will help minimize the total inventory costs (ordering costs plus holding costs) for this enterprise, given the specified demand, ordering cost, and holding cost.
Revision Table: Key Inventory Management Concepts
| Concept | Description | Relevance to EOQ |
|---|---|---|
| Annual Demand (D) | Total number of units required per year. | Directly proportional to EOQ (in the numerator). Higher demand usually means higher EOQ. |
| Ordering Cost (S) | Cost incurred each time an order is placed (e.g., administrative costs, shipping fees). | Directly proportional to EOQ (in the numerator). Higher ordering cost favors larger order quantities (higher EOQ) to reduce the number of orders. |
| Holding Cost (H) | Cost of carrying one unit in inventory for one year (e.g., storage costs, insurance, obsolescence). | Inversely proportional to EOQ (in the denominator). Higher holding cost favors smaller order quantities (lower EOQ) to reduce inventory levels. |
| Total Inventory Cost | Sum of total ordering cost and total holding cost. | EOQ minimizes this total cost. |
Additional Information: Assumptions of the Basic EOQ Model
It's important to understand the assumptions behind the basic EOQ model used here. These include:
- Demand is known, constant, and spread evenly throughout the year.
- Lead time (the time between placing an order and receiving it) is known and constant.
- The price per unit is constant and does not depend on the order quantity (no quantity discounts).
- Ordering cost is constant for each order.
- Holding cost per unit per year is constant.
- Inventory is received in a single delivery.
- There are no stockouts or shortages.
While these assumptions might not perfectly reflect real-world scenarios, the basic EOQ model provides a useful starting point for inventory decisions and can often be adapted for more complex situations.
Important Questions from Cost and Management Accounting
The marginal cost curve is ______
A company raises Rs. 1,00,000 by issue of 1000, 10% debentures of Rs. 100 each at a discount of 2% redeemable after 10 years. If the corporate tax rate is 40%, what would be the cost of capital?
1. 6.82%
2. 5.98%
3. 6.18%
4. 5.5%
Which of the following statements are true?
a) Pay - back period method considers all cash flows of a project
b) Pay - back period method concerns more with the recovery of cost than profitability
c) Net Present Value represents net addition to the wealth of shareholders
d) Accounting Rate of Return method incorporates risk as well as time value of money
Choose the correct option from those below.
Match List I with List II
List I
(Type of Costing)
List II
(Description)
A. Marginal Costing I. Integrated approach to determine product features, product price, product costs and product design that helps ensure a company to earn reasonable profit on new products. B. ABC Costing II. The amount of any given volume of output by which the aggregate costs are changed if the volume of output is increased by one unit. C. Target Costing III. Used when identical units are produced through an on-going series of production steps. D. Process Costing IV. Costing system in which costs being with tracing of activities and then to producing the product. Choose the correct answer from the options given below:
Which one of the following is PV ratio for the company?
