Model Answer
0 min readIntroduction
Inventory management is a critical aspect of operations, directly impacting a firm’s profitability and efficiency. Maintaining optimal inventory levels is a balancing act between minimizing costs associated with holding inventory and avoiding stockouts. The Economic Order Quantity (EOQ) model is a widely used technique to determine the ideal order quantity that minimizes the total inventory costs – ordering costs and carrying costs. This question requires us to apply the EOQ model to an engineering firm’s part procurement process, calculating the optimal order quantity and the corresponding days of supply.
Understanding the EOQ Model
The Economic Order Quantity (EOQ) is the order quantity that minimizes the total inventory costs. It’s based on the following assumptions: demand is constant and known, lead time is constant, ordering costs are constant, carrying costs are constant, and there are no stockout costs.
Formula for EOQ
The EOQ is calculated using the following formula:
EOQ = √(2DS / H)
Where:
- D = Annual demand in units (or value)
- S = Ordering cost per order
- H = Annual carrying cost per unit
Calculating the EOQ
In this case:
- D = ₹ 2,20,000 (Annual demand value)
- S = ₹ 350 (Ordering cost per order)
- Carrying cost = 15% of average inventory value
First, we need to determine the average inventory value. The average inventory is EOQ/2. Therefore, the carrying cost (H) is 0.15 * (EOQ/2). Substituting this into the EOQ formula makes it complex to solve directly. Instead, we can work with the cost per part.
Annual demand in units = Total annual value / Cost per part = ₹ 2,20,000 / ₹ 22 = 10,000 units
Now, we can recalculate the parameters:
- D = 10,000 units (Annual demand in units)
- S = ₹ 350 (Ordering cost per order)
- H = 15% of ₹ 22 = ₹ 3.30 (Annual carrying cost per unit)
EOQ = √(2 * 10,000 * 350 / 3.30) = √(2121212.12) ≈ 1456.4 units
Therefore, the Economic Order Quantity (EOQ) is approximately 1456 units.
Determining the Optimum Number of Days Supply
To determine the optimum number of days supply per optimum order, we need to calculate the number of days the EOQ will last based on the annual demand.
Days supply = (EOQ / Annual demand in units) * 365
Days supply = (1456 / 10,000) * 365 ≈ 52.5 days
Therefore, the optimum number of days supply per optimum order is approximately 53 days.
Sensitivity Analysis
It's important to note that the EOQ model is sensitive to changes in demand, ordering costs, and carrying costs. Any significant fluctuations in these parameters would necessitate a recalculation of the EOQ.
Conclusion
In conclusion, the engineering firm should order approximately 1456 units of the part per order to minimize its total inventory costs. This order quantity will provide approximately 53 days of supply. Implementing the EOQ model will help the firm optimize its inventory management, reduce costs, and improve overall operational efficiency. Regularly reviewing and adjusting the EOQ based on changing market conditions and cost structures is crucial for sustained benefits.
Answer Length
This is a comprehensive model answer for learning purposes and may exceed the word limit. In the exam, always adhere to the prescribed word count.