# Operations Management Principles Ip 4

By: Mike • Essay • 1,499 Words • February 8, 2010 • 661 Views

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Scheduling Pg.2

Raw Material LRM

Raw material is ordered in lots arriving at specific times but, consumed uniformed uniformly over a period. There are two types of costs involved in the process. One is the ordering cost, which is fixed per order and the other is the inventory holding cost, which depends on the average inventory level. The larger each order quantity, the fewer the number of orders placed in a year and hence, the lower the annual ordering cost. However large order quantities lead to higher levels of inventory and therefore higher annual inventory holding costs. Unfortunately, the ordering cost is incurred by the purchase department and the inventory holding cost by the operations department. The director of purchasing is reducing his departmentЎЇs cost (by having a large order quantity) while increasing the operation departmentЎЇs cost. (Stevenson, 2007)

Both departments should be working towards minimizing the total cost to the company. Hence, the economic order quantity (EOQ) should be determined such that the total cost to the company is minimized. The EOQ method does exactly this and hence, is ideal for calculating the optimum order quantity. It is simple to use and the assumptions it is based on are valid in this case. It is applied to a single product and process. The demand rate of the input is uniform over the usage period. The lead time for delivery of inputs is constant. Each order is received as a single delivery. There are no discounts for placing larger orders. (Stevenson, 2007)

Q = order quantity in units

In the existing case, Q = Q1 = 1000 units

Scheduling Pg. 3

In the suggested case, Q = Q2 = economic order quantity in units

H = holding cost per unit per year = 40 * 0.4 = $16 per unit per year

D = annual demand = 15000 units

S = ordering cost = $82 per order

Q2 = ЎМ (2*D*S/H) = 392 units

Table 1 computes the annual ordering, inventory carrying and total costs for the present order quantity (Q1) and the economic order quantity (Q2)

Table 1 - Annual Ordering, Inventory Carrying and Total Costs

Case 1 ЁC Existing Case 2 - Optimum Saving (+)/Loss (-)

Order quantity, Q units 1000 392

Annual holding cost = (Q/2)*H in $ 8000 3136 4864

Annual ordering cost = (D/Q)*S in $ 1230 3138 -1908

Total annual cost in $ 9230 6274 2956

Hence,

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