1. Calculate Economic Order Quantity © Dale R. Geiger 20111

2. What do 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. © Dale R. Geiger 20112

3. Terminal Learning Objective Action: Calculate Economic Order Quantity For Various Situations Condition: You are a cost advisor technician with access to all regulations/course handouts, and awareness of Operational Environment (OE)/Contemporary Operational Environment (COE) variables and actors. Standard: With at least 80% accuracy: 1.Describe the concept of economic order quantity 2.Identify the key variables in the EOQ calculation © Dale R. Geiger 20113

4. Batch Quantity Concepts © Dale R. Geiger 20114

5. 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 © Dale R. Geiger 20115

6. Batch Costs Batch Costs © Dale R. Geiger 20116

7. Batch Costs Batch Costs © Dale R. Geiger 20117

8. Batch Costs Batch Costs © Dale R. Geiger 20118

9. Batch Costs Batch Costs © Dale R. Geiger 20119

10. Batch Costs Batch Costs © Dale R. Geiger 201110

11. Batch Costs Batch Costs © Dale R. Geiger 201111

12. Batch Costs Batch Costs Regardless of how you look at it: More units in a batch mean fewer batches Fewer batches mean lower Batch costs © Dale R. Geiger 201112

13. Check on Learning How does batch cost per unit change as batch size increases? What are the key assumptions in batch quantity tradeoffs? © Dale R. Geiger 201113

14. Batch Cost Example Purchasing supplies is a common example of a Batch cost Each purchase order issued costs the organization $250 Demand for supplies is 200 units © Dale R. Geiger 201114

15. Batch Cost Example How much is purchasing cost if a separate purchase order is issued for each unit of supplies? 200 purchase orders * $250/ purchase order = $50,000 How much is purchasing cost if all 200 units are purchased using a single purchase order? 1 purchase order * $250/ purchase order = $250 © Dale R. Geiger 201115

16. Batch Cost Example © Dale R. Geiger 201116

17. Batch Cost Example © Dale R. Geiger 201117

18. Graph of Purchasing Cost $ X-Axis = Number of units per purchase order or batch As number of units per PO or batch increases, purchasing cost decreases © Dale R. Geiger 2011 18

19. Questions to Consider Using only this information for your decision, how many units should be ordered per purchase order? Similarly, what savings might be achieved by training all of the soldiers needed for a particular task in one large group? What else should be considered? © Dale R. Geiger 201119

20. Check on Learning How would you describe the graph of batch cost? © Dale R. Geiger 201120

21. Batch Quantity Concepts Certain costs increase as quantity per purchase order increases Inventory ties up cash and must be stored and maintained Spoilage and obsolescence can occur Time value of money – cash paid now is worth more than cash paid later “Just in Time” ordering minimizes these “Holding Costs” © Dale R. Geiger 201121

22. Questions to Consider What might be the “holding costs” involved with training all of the soldiers required for a particular task in one large group or “batch”? © Dale R. Geiger 201122

23. Holding Cost Assumptions Annual Holding Cost is linear or variable on a per-unit basis Units produced or purchased in batches are consumed or sold uniformly throughout the period © Dale R. Geiger 201123

24. Holding Costs Holding cost = $Holding Cost/Unit * Avg. #Units in Inventory Average #Units in Inventory = #Units per Purchase Order/2 Assumes Inventory is consumed uniformly throughout the year © Dale R. Geiger 201124

25. Graph of Inventory Assumption 50 Units produced or purchased per batch X axis represents time © Dale R. Geiger 2011 25

26. Graph of Inventory Assumption Units Consumed or Sold uniformly until all Inventory is gone 25.00 © Dale R. Geiger 2011 26

27. Graph of Inventory Assumption Average Inventory is 50/2 or 25 Units 25.00 X axis represents time © Dale R. Geiger 2011 27

28. Check on Learning What are the underlying assumptions related to holding costs? How is average inventory calculated? © Dale R. Geiger 201128

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 = 1 unit/2 or ½ unit ½ unit * $50/unit = $25 What is holding cost if all 200 units of supplies are purchased on one purchase order? Average inventory = 200 units/ 2 or 100 units 100 units * $50/unit = $5,000 © Dale R. Geiger 201129

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 = 1 unit/2 or ½ unit ½ unit * $50/unit = $25 What is holding cost if all 200 units of supplies are purchased on one purchase order? Average inventory = 200 units/ 2 or 100 units 100 units * $50/unit = $5,000 © Dale R. Geiger 201130

31. 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 = 1 unit/2 or ½ unit ½ unit * $50/unit = $25 What is holding cost if all 200 units of supplies are purchased on one purchase order? Average inventory = 200 units/ 2 or 100 units 100 units * $50/unit = $5,000 © Dale R. Geiger 201131

32. Graph of Holding Cost $ X-Axis = Number of units per purchase order As number of units per purchase order increases, holding cost increases When quantity per purchase order is 10 Average Inventory = 5 and holding cost is $250 When quantity per purchase order is 10 Average Inventory = 5 and holding cost is $250 When quantity per purchase order is 100 Average Inventory = 50 and purchasing cost is $2,500 When quantity per purchase order is 100 Average Inventory = 50 and purchasing cost is $2,500 © Dale R. Geiger 2011 32

33. Check on Learning How does holding cost change as batch quantity changes? How is holding cost represented on the graph? © Dale R. Geiger 201133

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 © Dale R. Geiger 201134

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 © Dale R. Geiger 201135

36. 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 © Dale R. Geiger 201136

37. Graph of Total Costs ≈45X-Axis = Order quantity in units Total Cost is minimized where Purchasing Cost = Holding Cost Total Cost is minimized where Purchasing Cost = Holding Cost © Dale R. Geiger 201137

38. 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 © Dale R. Geiger 201138

39. Optimizing Order Quantity © Dale R. Geiger 201139

40. Calculating EOQ © Dale R. Geiger 201140

41. Check on Learning What are the three variables used in the Economic Order Quantity formula? How will EOQ change if holding cost per unit increases while all other variables remain the same? © Dale R. Geiger 201141

42. Practical Exercise © Dale R. Geiger 201142

43. Batch Quantity Spreadsheet © Dale R. Geiger 201143 Enter batch cost, holding cost, and demand into the spreadsheet to generate the graph of total cost

44. Practical Exercise © Dale R. Geiger 201144