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Unit 7: Inventory Management




          one-half  the order  quantity. Therefore, the larger the order quantity, the larger the average  Notes
          inventory and consequently, the greater the maintenance cost per year. However, the larger the
          order quantity, the fewer orders required per planning period and, consequently, the lower the
          total ordering cost. Lot quantity formulations identify the precise quantities at which the annual
          combined total cost of ordering and maintenance is lowest for a given sales volume.
          Economic Order Quantity


          The Economic Order Quantity (EOQ) is the replenishment order quantity that minimizes the
          combined cost of inventory maintenance and ordering. Identification of such a quantity assumes
          that demand and costs are relatively stable throughout the year.


               !
             Caution Since an EOQ is calculated on an individual product basis, the basic formulation
             does not consider the impact of joint ordering of products.

          The most efficient method for calculating economic order quantity is mathematical. To make
          the appropriate calculations, the standard formulation for EOQ is

                    EOQ =  2CoD/CiU
          Where     EOQ = economic order quantity (EOQ)
                      Co = cost per order

                      Ci = annual inventory carrying cost
                       D = annual sales volume, units
                       U = cost per unit
          While the EOQ model determines the optimal replenishment  quantity, it  does require some
          rather stringent assumptions that constrain its direct application. The major assumptions of the
          simple EOQ model are:

          1.   Satisfaction of all demand
          2.   Continuous, constant, and known rate of demand
          3.   Constant and known replenishment performance-cycle time
          4.   Constant price of product that is independent of order quantity or time (i.e., no purchase
               quantity or transportation price discounts are available)
          5.   Infinite planning horizon
          6.   No interaction between multiple items of inventory
          7.   No inventory in transit

          8.   No limit on capital availability. The constraints imposed by some of these assumptions
               can be overcome through computational extensions. However, the EOQ concept illustrates
               the importance of the trade-offs associated with holding and acquisition cost.

          EOQ Extensions
          While the EOQ formulation is relatively straightforward, there are some other factors that must
          be considered in actual application. The most persistent problems are those related to various
          adjustments  necessary  to  take  advantage  of  special  purchase  situations and  unitization
          characteristics.



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