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Calculate Economic Order Quantity Intermediate Cost Analysis and Management © 2011 What you think? Corporal O’Reilly, the supply clerk, knows that it costs the Army money to generate a purchase order To save money he proposes ordering the five years’ worth of ammunition at once © 2011 Terminal Learning Objective • Action: Calculate Economic Order Quantity for Various Situations • Condition: You are training to become an ACE with access to ICAM course handouts, readings, and spreadsheet tools and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors • Standard: With at least 80% accuracy: • Describe the concept of economic order quantity • Identify the key variables in the EOQ calculation  © 2011 Batch Quantity Concepts •  Certain costs are fixed on a per-batch basis • Setting up machinery to run a particular product • Purchasing cost • Training cost • We call these “Batch Costs” • More units in a batch means lower batch cost per unit Batch cost per unit = © 2011 Batch Cost Assumptions • Annual demand for units produced in batches is known • Every batch is the same size • i.e same quantity of units produced © 2011 Batch Costs •  Batch Cost = Batch Cost per Unit * # Units Demanded -or- * #Units Demanded â 2011 Batch Costs Another way of thinking of Batch costs is: # of Batches * Cost per Batch -or* Batch $Cost © 2011 Batch Costs •  The full equation is: • First divide # units demanded by # units in batch to get # of batches, then multiply by Batch $ Cost © 2011 Batch Costs •  The full equation is: • First divide # units demanded by # units in batch to get # of batches, then multiply by Batch $ Cost © 2011 Batch Costs •  The full equation is: • Or, first divide Batch $ Cost by # Units in batch to get Batch cost per unit, then multiply by # units demanded â 2011 10 Holding Cost Example Annual holding cost for supplies is $50 per unit • What is holding cost if each unit of supplies is purchased on its own purchase order? • Average inventory = unit/2 or ẵ unit ẵ unit * $50/unit = $25 • What is holding cost if all 200 units of supplies are purchased on one purchase order? • Average inventory = 200 units/ or 100 units • 100 units * $50/unit = $5,000 © 2011 29 Holding Cost Example • Annual holding cost for supplies is $50 per unit • What is holding cost if each unit of supplies is purchased on its own purchase order? • Average inventory = unit/2 or ẵ unit ẵ unit * $50/unit = $25 • What is holding cost if all 200 units of supplies are purchased on one purchase order? • Average inventory = 200 units/ or 100 units 100 units * $50/unit = $5,000 â 2011 30 Holding Cost Example • Annual holding cost for supplies is $50 per unit • What is holding cost if each unit of supplies is purchased on its own purchase order? Average inventory = unit/2 or ẵ unit ẵ unit * $50/unit = $25 What is holding cost if all 200 units of supplies are purchased on one purchase order? • Average inventory = 200 units/ or 100 units • 100 units * $50/unit = $5,000 © 2011 31 Graph of Holding Cost Holding Cost $ 5000 4500 4000 3500 3000 2500 2000 1500 1000 500 When quantity per purchase order is 10 Average Inventory = and holding cost is $250 When quantity per purchase order is 100 Average Inventory = 50 and purchasing cost is $2,500 50 100 150 X-Axis = Number of units per purchase order As number of units per purchase order increases, holding cost increases © 2011 200 32 Learning Check • How does holding cost change as batch quantity changes? • How is holding cost represented on the graph? â 2011 33 Optimizing Order Quantity Total Costs Related to Order Quantity = Purchasing Cost + Holding Cost • What is Total Cost when Quantity per order is 10 units? 5000 + 250 = 5250 • What is Total Cost when Quantity per order is 100 units? 500 + 2500 = 3000 © 2011 34 Optimizing Order Quantity • Total Costs Related to Order Quantity = Purchasing Cost + Holding Cost • What is Total Cost when Quantity per order is 10 units? 5000 + 250 = 5250 • What is Total Cost when Quantity per order is 100 units? 500 + 2500 = 3000 © 2011 35 Optimizing Order Quantity • Total Costs Related to Order Quantity = Purchasing Cost + Holding Cost • What is Total Cost when Quantity per order is 10 units? 5000 + 250 = 5250 • What is Total Cost when Quantity per order is 100 units? 500 + 2500 = 3000 © 2011 36 Graph of Total Costs 5000 4500 Total Cost is minimized where Purchasing Cost = Holding Cost 4000 3500 3000 Purchasing Cost Holding Costs Total Cost 2500 2000 1500 1000 500 0 20 40 60 ≈45 80 100 120 140 160 180 200 X-Axis = Order quantity in units © 2011 37 Optimizing Order Quantity • Total Cost is minimized at the order quantity where Holding Cost = Purchasing Cost • Computation of this “Indifference Point” requires calculus beyond the scope of this course © 2011 38 Optimizing Order Quantity • The   relationship is well-documented and is captured in the “Economic Order Quantity” (EOQ) Formula: EOQ = d = Demand in units p = cost per Purchase Order h = Holding cost per unit © 2011 39 Calculating EOQ • Demand   is 200 units • Purchasing Cost is $250 per Order • Holding Cost is $50 per Unit EOQ = EOQ = = approx 45 units © 2011 40 Practical Exercise © 2011 41 Batch Quantity Spreadsheet Enter batch cost, holding cost, and demand into the spreadsheet to generate the graph of total cost © 2011 42 Practical Exercise © 2011 43 ... 50 00 450 0 4000 350 0 3000 250 0 2000 15 0 0 10 00 50 0 50 00 When quantity per purchase order is 10 , twenty purchase orders are issued and purchasing cost is $50 00 When quantity per purchase order is 10 0,... purchase orders * = $50 ,000 • How much is purchasing cost if all 200 units are purchased using a single purchase order? purchase order * = $ 250 © 2 011 17 Graph of Purchasing Cost Purchasing Cost $ 50 00... $ 250 / purchase order = $50 ,000 • How much is purchasing cost if all 200 units are purchased using a single purchase order? purchase order * $ 250 / purchase order = $ 250 â 2 011 15 Batch Cost Example