MA – Nov 2018 – L2 – Q3a – Cost-volume-profit (CVP) analysis

Calculation of the Economic Order Quantity (EOQ) and analysis of the impact of a quantity discount on total inventory costs.

Question

The quarterly demand for an item of raw materials is estimated at 2,000 units at a purchase price of GH¢180 per unit. It is estimated that the cost per order will be GH¢270 and the cost of holding a unit of material in inventory will be GH¢24.

Required:

i) Compute the optimal order quantity, and total minimum costs. (4 marks)

ii) Suppose a supplier offers 5% quantity discount for purchase of 8,000 units, should the offer be accepted? (3 marks)

Answer

i) Economic Order Quantity (EOQ) Calculation:

The EOQ formula is given by:

Where:

$D$ = Demand (2,000 units per quarter = 8,000 units per year)
$C_o$ = Ordering Cost (GH¢270)
$C_h$ = Holding Cost per unit (GH¢24)

Total Costs:

Holding Costs:
Ordering Costs:

ii) Total cost with discount:

Purchase cost 8,000 @ 171 (after 5% discount) = GH¢1,368,000
Ordering cost
Holding cost

Decision:

The decision should be to reject the offer as the EOQ model without the discount results in lower total costs.

Tags: Discounts, Economic Order Quantity (EOQ), Holding costs, Inventory Costs, Ordering costs
Level: Level 2

Topic: Cost-Volume-Profit (CVP) Analysis
Series: NOV 2018

Uploader: Kwame Aikins