Managing Inventory: EOQ Model

Question 1

Economic Order Quantity:

How many units should we order?

Answer 1

Find optimal Q*
E(d) x (variance in the demand %)

Looking to minimize C(Q)

C(Q) = (annual ordering costs when order size is Q) + (annual holding costs when order size is Q)

C(Q) = ((Q / 2) x h) + ((D / Q) x K)

Question 2

EOQ assumptions

Answer 2

1. There is no demand uncertainty; management knows future demand
2. Demand is constant
3. Inventory is immediately replenished; the lead time to restore inventory is zero
4. There is a fixed cost independent of the number of units ordered.

Question 3

EOQ assumption 1

Answer 3

There is no demand uncertainty.

No stock-out cost.

Question 4

EOQ assumption 2

Answer 4

Demand is constant over time; inventory held drops at a constant rate

Question 5

EOQ assumption 3

Answer 5

Saw-tooth diagram

Inventory is immediately replenished; the lead time to restore inventory is zero;

before customers reflect demand, inventory equals Q;

when inventory falls to zero, order of Q is placed and received.

Question 6

EOQ assumption 4

Answer 6

There is a fixed cost outside of the cost linked to the qty of units ordered.

The annual ordering cost (K)

(P.23 HBP managing inventory)

Question 7

General EOQ problem: variables

Answer 7

D = demand

N = number of orders placed per year

Q = order qty; number of units per order

h = annual inventory holding cost per unit; the annual carrying cost per unit

K = ordering cost; the cost to place and receive an order

C(Q) = annual cost linked to order qty (Q) per year

Question 8

Q - order qty

Answer 8

Q is in units per order

N = (D units / year) / (Q units / order) = (D/Q) orders/year

Annual order cost = (D/Q) x orders/year x (K/year) = (D / Q) x (K / year)

Q = SQR [(2KD) / (h)]

*plug Q back into C(Q)

P. 23 managing inventory