Philippine School of Business Administration

826 R. PAPA STREET, SAMPALOC MANILA

INVENTORY CONTROL MODEL:

● The purpose of inventory control is to minimize the total cost of inventory.
● There are three main factors in inventory control decision-making process are:
o The cost of holding the stock (e.g. based on the interest rate),
o The cost of placing an order (for raw material stocks) or the set up cost of
production. And the cost of shortage (what is loss of the stock is insufficient to
meet all demand),
o The third element is the most difficult to measure and is often handled by
establishing a service-level policy (a certain percentage of demand will be met
from stock without delay).
The inventory control is the systematic storing of resources for current or future needs. It will be
introduced with the following assumptions:
1. There is an order quantity that will minimize the cost.
2. There is a safety stock quantity that will minimize cost.
This chapter will introduce 3 models presented in different examples:
1. Simple EOQ Model – determining how much to order
2. Production Run Model
3. Quantity Discount Model
Assumptions of EOQ Model:
1. Demand is known and constant
2. Lead time is known and constant
3. Receipt of inventory is instantaneous
4. Quantity discounts are not available
5. Variable costs are limited to: ordering cost and carrying (or holding) cost
6. If orders are placed at the right time, stock outs can be avoided

Inventory Level Overtime based on EOQ Assumptions

Dominic Q. Taday
 Philippine School of Business Administration
826 R. PAPA STREET, SAMPALOC MANILA

SIMPLE ECONOMIC ORDER QUANTITY (EOQ) MODEL

LEGENDS:
*
𝑄 - Optimal order quantity
D – Annual demand
𝐶0 – Ordering cost per order

𝐶ℎ - Carrying (holding) cost per unit per year

P – Purchase cost per unit

L – Lead-time
W – Working days per year
Example: JVC Flat Screen TV
Manuel, the purchasing manager of JVC Flat Screen TV, wants to determine the most optimum
inventory practice for the company. He was able to determine the demand and inventory costs
needed in his analysis. The annual demand is 1,000 units; the ordering cost is $ 10,000 per order
and the holding cost is $500 per unit per year. It will take 20 days for an order to arrive and there
are 250 working days per year.
What is the economic order quantity? How much is the total annual inventory cost? What is the
reorder point?

ITEM VALUE
Annual Demand D (units) 1,000
Ordering Cost per order 𝐶0 (x1000) 10
Holding cost unit year 𝐶ℎ (x1000) 0.5
Lead-time L (days) 20
Working days per year W 250

*
Step 1: Determine the EOQ (𝑄 )
*
TABLE 2. Computation for 𝑄
*
ECONOMIC ORDER QUANTITY (𝑄 )
ITEM UNITS ITEM COST
D 1000 𝐶0 10

𝑄
* 200 𝐶ℎ 0.5

Dominic Q. Taday
 Philippine School of Business Administration
826 R. PAPA STREET, SAMPALOC MANILA

Step 2: Determine the total annual inventory cost.

TOTAL ANNUAL INVENTORY COST TABLE

Total Annual Inventory Cost (x $1000)
Units Number of 𝐶0
D * Orders O Per Order Total
𝑄
1000 200 5 10 50
Inventory Units 𝐶ℎ
Beginning Ending Average Per Unit/yr Total
200 0 100 0.5 50
Total annual inventory cost (x 1000) 100

Step 3: Determine the reorder point

REORDER POINT TABLE
REORDER POINT (ROP) UNITS
Annual Demand D 100
Leadtime L (days) ROP
Working days/yr W 250
Daily Demand d 4 20 80

PRODUCTION RUN MODEL:

For this section, the following data are known:
1. Annual demand (D)
2. Setup cost per setup 𝐶𝑠( )
3. Holding cost per unit per year 𝐶ℎ ( )
4. Daily production rate (p)
5. Working days per year (W)

Example: Sony Flat Screen TV

Nancy, the head buyer of Sony Flat Screen TV, wants to determine the most optimum inventory
practice for the company. She was able to determine the demand and inventory costs needed in
her analysis. The annual demand is 10,000 units, the cost to set up the machinery for production
is $10,000 per set up and the holding cost is $1,000 per unit per year. The production rate was 50
units per day and there are 250 working days per year.
What is the economic order quantity? How much is the total annual inventory cost? What is the
production cycle?
DATA FOR SONY FLAT SCREEN TV TABLE
ITEM VALUE
Annual Demand D (units) 1,000

Dominic Q. Taday
 Philippine School of Business Administration
826 R. PAPA STREET, SAMPALOC MANILA

Ordering Cost per order 𝐶0 (x1000) 10

Holding cost unit year 𝐶ℎ (x1000) 1
Daily production rate p 50
Working days per year W 250

Step 1: Determine the EOQ

ECONOMIC ORDER QUANTITY TABLE
*
ECONOMIC ORDER QUANTITY (𝑄 )
ITEM UNITS ITEM COST
D 10,000 𝐶𝑠 10
d 40 𝐶ℎ 1
p 50 Production days
* 1,000 cycle 20
𝑄
Step 2: Determine the total annual inventory cost
INVENTORY COST TABLE
Total Annual Inventory Cost (x $1000)
Units No, of 𝐶𝑠 (x $1000)
Setup S
D 𝑄
* Per Setup Total
10,000 1,000 10 10 100
Inventory Units 𝐶ℎ (x $1000)

Maximum Minimum Average Per Unit/yr Total

200 0 100 1 100
Total annual Inventory Cost (x $1,000) 200

QUANTITY DISCOUNT MODEL

For this section, the following data are known:
1. Annual demand (D)
2. Ordering cost per Order 𝐶𝑜 ( )
3. Holding cost % of cost ( I )
4. Purchase cost per unit (C)
5. Discount rate based on volume purchased (r)

Example: Samsung Flat Screen TV

Osler, the Materials Director of Samsung Flat Screen TV, wants to determine the most optimum
inventory practice for the company. He was able to determine the demand and inventory cost
needed in his analysis. The annual demand is 10,000 units. The ordering cost is $100,000 per
order, and the holding cost per unit per year is 30% of the product cost which is $50,000 per unit.

Dominic Q. Taday
 Philippine School of Business Administration
826 R. PAPA STREET, SAMPALOC MANILA

There is no discount if the volume of purchase is less than 1,000 units. 1% discount if the volume
is at least 1,000 units, and 2% discount if the volume is at least 2,000 units.
What is the economic order quantity? How much is the total annual inventory cost? How many
units should be purchased?

DATA FOR SAMSUNG FLAT SCREEN TV

Item Value
Annual demand (D) 10,000
Ordering cost per Order 𝐶𝑜 ( ) 100

Holding cost % of cost ( I ) 30%

Discount Discount Cost/Unit C Discount
Level Quantity (x 1000) (%)
1 0-999 50 0
2 1,000-1,999 50 1
2,000 and
3 50 2
up

Step 1: Determine the EOQ

ADJUSTED EOQ TABLE
Discount Discount Discounted 𝐶ℎ Q* Adjusted
Level Quantity Cost (x 1000) (x1,000) (Units) Q* (Units)
1 0-999 50.00 15.00 365 365
2 1,000-1,999 49.50 14.85 367 1000
3 2,000 and up 49.00 14.70 369 2000

Step 2: Determine the Total annual cost

TOTAL ANNUAL COST TABLE
Discount Annual Cost (x $1000) Minimum?
Level Purchase Ordering Holding Total Yes/No
1 500,000 2,740 2,738 505,478 No
2 495,000 1,000 7,425 503,425 Yes
3 490,000 500 14,700 505,200 No

Dominic Q. Taday
 Philippine School of Business Administration
826 R. PAPA STREET, SAMPALOC MANILA

Dominic Q. Taday