Chapter 4

Inventory Models for Independent Demand

Chapter Outline
1. Introduction
2. Classifications of the models for ID
3. Fixed Order Quantity Models
4. Fixed Order Interval Models
5. Economic Order Quantity/ EOQ/ Model
6. Production Order Quantity/POQ/ Model
7. Quantity Discount Model

2
Chapter Learning Outcomes
1. Describe replenishment ordering techniques
2. Understand the order point model
3. Calculate order point safety stock
4. Determine the replenishment order quantity
5. Identify the components of inventory
carrying cost
6. Calculate the economic order quantity (EOQ)
7. Manage with minimum and maximum
ordering
4.1. Introduction
 This chapter deals with the independent
demand methods of inventory
management and control system.
 As described in the previous chapter of our
lecture, the independent demand methods
assume that the demand for an item is
independent of the demand for any other item.
 Then the aggregate demand for an item is
made up of many independent demands from
separate customers – in the way that the overall
demand for milk in a supermarket is made up of
many small demands from separate customers.
4
 For such situations, some Japanese companies were
pioneers in introducing the just-in-time inventory
system—a system that emphasizes planning and
scheduling so that the needed materials arrive “just-in-
time” for their use. Huge savings are thereby achieved
by reducing inventory levels to a bare minimum.
 Likewise, many companies in other parts of the world
also have been revamping the way in which they
manage their inventories for independent demand
products.
 The application of operations research techniques in
this area (sometimes called scientific inventory
management) is providing a powerful tool for gaining a
competitive edge.
5
 In the scientific inventory management, stock control is
based on quantitative models that relate forecast demand,
costs and other variables, to find optimal values for order
quantities and timing.
 Specifically, companies use operations research to improve
their inventory policy for when and how much to replenish
their inventory comprising the following steps:
1. Formulate a mathematical model describing the behavior of
the inventory system.
2. Seek an optimal inventory policy with respect to this model.
3. Use an information processing system to maintain a record
of the current inventory levels.
4. Using this record of current inventory levels, apply the
optimal inventory policy to signal when and how much to
replenish inventory.

6
 4.2. Classifications of the models for ID
 Several factors have been used by researchers to classify
inventory models.
 Some of these factors include:

1. Timing of inventory status review (continuous, periodic)

2. Nature of demand of item (deterministic, probabilistic, varying
by period, etc.)
3. Nature of replenishment lead time (constant, varying, etc.)
4. Number of items under management (single, multiple)
5. Number of locations or supply sources (single, multi-echelon)
6. Possibility of repetitive orders (single period, multiple periods)
7. Lifetime of items being managed (perishable, infinite lifetime)
8. Other factors (reparability of items, constraints, quantity
discounts, coordinated replenishment, etc.)

7
 Fig. … Classification of inventory models

8
 As illustrated in the figure according to the
predictability of demand involved, the
mathematical inventory models used in the
independent demand items can be divided
into two broad categories :
1. Deterministic models and
2. Stochastic models.
 The demand for a product in inventory is the
number of units that will need to be
withdrawn from inventory for some use (e.g.,
sales) during a specific period.

9
 If the demand in future periods can be
forecast with considerable precision, it is
reasonable to use an inventory policy that
assumes that all forecasts will always be
completely accurate.
 Thisis the case of known demand where a
deterministic inventory model would be used.
 However, when demand cannot be predicted
very well, it becomes necessary to use a
stochastic inventory model where the
demand in any period is a random variable
rather than a known constant.

10
 Alternatively, as we tried to see in Chapter 4,
these models can be either:
 Fixed order quantity model
 Periodic Review model/ Fixed order interval
model.
 Flow system, or
 Two- bin system.
 The following sections of the chapter address
these models indepth.

11
4.3 Fixed Order Quantity
System

 Is a system in which a predetermined

fixed quantity to be ordered when the
stock level on hand drops to a
predetermined order point
 Also known as:
 Order point system
 Q- system
 maximum-minimum system
 Perpetual system
 Continuous system
 (Q, R) policy: Whenever inventory falls to a
reorder level R, place an order for Q units
12
 Quantity

Fixed order
quantity
Slope = Rd

Re-order Re-order Re-order Re-order

level

Safety
stock { Lead-time

Time

13
 Receipt of the new order then increases the
stock level to a planned maximum figure.
 The system is applied most commonly by
maintaining a perpetual inventory record for
each item carried in stock.

14
How ROP Determined?

ROP = Average demand during lead

time
+
Safety Stock

 As noted from the formula, the reorder

level has two components

15
1) The average
demand during 2) Safety stock
lead time
 buffer added to on
 Estimated usage
hand inventory during
of the item during lead time to offset
the lead time variability in demand
period and lead time
 use safety stock to
 Depends on daily achieve a desired
demand and lead service level and
avoid stock-outs:
time  Stock out
 an inventory shortage
 Service level
 probability that the
inventory available
16 during lead time will
4 Situations to determine ROP

 Constant demand rate, constant lead time

 Variable demand rate, constant lead time
 Constant demand rate, variable lead time
 Variable demand rate, variable lead time

17
Demand is constant and lead time is
constant
R  dL
Illustration
Demand = 10,000 gallons/year
Store open 311 days/year
Daily demand = 10,000 / 311 = 32.154
gallons/day
Lead time = L = 10 days

R = dL = (32.154)(10) = 321.54 gallons

18
Demand is variable and lead time is
constant
R = dL + zd L
where

d = average daily demand

L = lead time
d = the standard deviation of daily
demand
z = number of standard deviations
corresponding to the service
level
probability
19 zd L = safety stock
Illustration

Average daily demand (normally

distributed) = 15 Z for 90% = 1.28
Standard deviation = 5 From NC
Lead time is constant at 2 days
90% serviceR level
= dLdesired
+ z L
d

ROP
= 30 + 1.28(5)( 2)
= 30 + 9.02 = 39.02 ≈ 39
units
Safety stock is about 9 units
20
Fixed Order Quantity System (con.)

Lead time is variable and demand is

constant
ROP = (daily demand x
average lead time in days) +
Z x (daily demand) x sLT

where sLT = standard deviation of lead time in days

21
Illustration

Daily demand (constant) = 10

Average lead time = 6 days
Standard deviation of lead time = sLT = 3
98% service level desired Z for 98% = 2.055
From NC

ROP = (10 units x 6 days) + 2.055(10

units)(3)
= 60 + 61.65 = 121.65
Reorder point is about 122 cameras

22
 Both demand and lead time are
variable
ROP = (average daily
demand
x average lead time) +
= ZsdLT
standard deviation of demand per day
= standard deviation of lead time in days

T = (average lead time x sd2)

(average daily demand)2 x sLT2

23
Illustration

Average daily demand (normally

distributed) = 150
Standard deviation = sd = 16
Average lead time 5 days (normally
distributed)
Standard deviation = sLT = 1 day
95% service level desired Z for 95% = 1.65
From NC

ROP = (150 packs x 5 days) + 1.65sdLT

= (150 x 5) + 1.65 (5 days x 162) +
(1502 x 12)
24 = 750 + 1.65(154) = 1,004 packs
Advantages
 Each material can be produced or
purchased in the most economical
quantity.
 Purchasing and inventory control personnel
automatically devote attention to the items
that need it only when required, and
 Positive control can easily be exerted to
maintain total inventory investment at the
desired level simply by manipulating the
planned maximum and minimum values.
25
Disadvantages
 It functions correctly only if each of the
materials exhibits reasonably stable usage
and lead time.
 The system becomes extremely
cumbersome to operate effectively when
applied to materials with unstable usage
patters and lead times.
 As with any system using a perpetual
inventory record, errors in posting and in
the issuance of stores requisitions
occasionally distort book balances and
may lead to undetected materials
26
shortages
4.4. Fixed Order Interval
Model
 4.4.1. Fixed Order Interval System
 Is a time-based system,
 which involves scheduled periodic reviews of the
stock levels of all inventory items, and
 when the stock level of a given item is not
sufficient to sustain operation until the next
scheduled review, an order is placed to replenish
the supply.

27
 Figure…Fixed Order Interval
System

Periodic reviews

B
A C D
Quantity

Lead-time Lead-time Lead-time

Safety
Stock
{
Z Time
Fixed
Lead-time
review

28
Fixed Order Interval System
(cont.)
 Fixed Order Interval System is also known
as:
Fixed-period system

 P-system
 Cyclical order system
 Periodic review system
 (s, S) system
 The order size varies
 The frequency of reviews also varies
 From firm to firm.
 Among materials: depending upon the
importance of the material, specific production
schedules, market conditions, and so on.
29
 (s, S) policy:
 during each inventory review, if inventory falls
below s, order enough quantity to raise the
inventory position to S
 S is known as the base stock level or the
target inventory level

30
 How to compute the base stock level?
 At the time order is placed, this order
raises the inventory position to the base-
stock level which is expected to be enough
to protect against shortage until the next
order arrives.
 The next order arrives after a period of r +
L days, the current order should be enough
to cover demand during a period of r + L
days

31
If
 r be the length of the review period
 Orders are placed every r periods of time
 L is the lead time
 AVG average daily demand
 STD standard deviation of daily demand
 Z safety factor which depends on level of service

32
The base-stock level should include two
components
 Average demand during an interval of
r + L which is equal to
 (r * L) X AVG
 Safety stock: the amount of inventory
that needs to be kept to protect against
deviations from average demand during a
period of r + L days which is computed as:
 Z X STD X SQRT of (r + L)

33
 the base-stock or target stock level is
determined using:

((r + L) X AVG) + (Z X STD X √(r +L))

34
Illustration
 Average demand per week 44 units
 Standard deviation of demand is 32 units
 Lead time is 2 weeks
 Order is placed every 3 weeks
 Service level is 97% (z = 1.88)
 Calculate the base stock level
 The base stock level is: ((3 X 2) x 44) +
(1.88 x 32 x √(3+2)= 398.52.

35
 Order Size

 Order Size=(Demand over the review interval +

demand during the lead-time) - (Actual stock) -
(Pipeline stock) +(Safety stock)

36
Given the following data, what quantity should
be re-ordered?
Expected demand per week = 100
Lead time = 3 weeks
Review interval = 4 weeks
Safety stock = 300
Physical stock = 450
On order (pipeline) = 200
ORDER QUANTITY= 350

37
 The cyclical ordering system is well suited
for materials
 whose purchases must be planned months in
advance because of established and infrequent
production schedules maintained by suppliers.
 which exhibit an irregular or seasonal usage

38
Problems
 May result in stock-outs between
review periods
 May require increased safety stock
 Tends to peak the purchasing
workload around the review dates.
 Actual order quantities may deviate
substantially from the optimum
(Economic order quantity).

39
4.4.2 Flow Control System
 Is a variation of the fixed order interval
system
 Is applicable in continuous manufacturing
operations which produce the same basic
product in large quantities day after day.
 Most materials used in such an operation
are;
 purchased on term contracts, and
 scheduled for daily or weekly delivery
throughout the term.
 Material flows through the plant in
continuous streams.
 Minimum investment in production
40
inventory.
4.4.3. Two - Bin system
 Is another variation of the fixed order
quantity system.
 The distinguishing feature of this system is
the absence of a perpetual inventory
record.
 The stock is physically separated into two
bins or containers.
 Lower bin
 Upper bin

41
Two - Bin system (cont.)
 Lower bin
 contains a quantity of stock equal to the order
point figure.
 Contains enough stock (or slightly more) to last
from the date a new order is prepared until the
incoming material is received in inventory.
 Upper bin
 contains a quantity of stock equal to the
difference between the maximum and the order
point figures

42
Two - Bin system (cont.)
 At the out set, stock is used from the upper
bin
 When the stock in the upper bin is depleted:
 it signals the clerk that the reorder point has been
reached.
 at this point an order is placed, and
 material is used from the lower bin until the new
stock is received.

43
Two - Bin system (cont.)
 Upon receipt of the new order, the proper
quantities of material are again placed in the
two bins.
 Widely used in handling low value hardware
and supplies their usage is not recorded on a
perpetual record

44
4.5 Economic Order Quantity / EOQ/ Model
 The most common inventory situation faced
by manufacturers, retailers, and wholesalers is
that stock levels are depleted over time and
then are replenished by the arrival of a batch
of new units.
 A simple model representing this situation is
the economic order quantity model or, for
short, the EOQ model.
 It sometimes is also referred to as the
economic lot-size model.

45
 The basic EOQ Model:
 optimal order quantity that will
minimize annual (total) inventory
costs
 Total inventory cost:
 Annual carrying cost
 Annual ordering or setup cost
 Annual purchasing cost
 Determines the order quantity at
which annual ordering cost equals
annual inventory carrying cost.
46
Objective is to minimize total
costs
Curve for total
cost of holding
and setup

Minimum
total cost
Annual cost

Holding cost
curve

Order (or setup)

cost curve
Optimal order Order quantity
quantity (Q*)

47
Assumption of EOQ
1. Demand is known, constant, and
independent.
2. Lead time is known and constant.
3. Receipt of inventory is instantaneous and
complete.
4. Quantity discounts are not possible.
5. Only variable costs are order/setup and
holding costs.
6. Stock-outs can be completely avoided.
 The EOQ Model
Q = Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
O = Ordering or Setup cost for each order
H = Holding or carrying cost per unit per year

Annual ordering or setup cost =(Number of orders placed per year)

x (Setup or order cost per order)

Annual demand Order/ Setup

=
Number of units in each order cost per order

D
= (O)
Q

49
 The EOQ Model
Q = Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
O = Ordering/Setup cost for each order
H = Holding or carrying cost per unit per year

Annual holding cost = (Average inventory level)

x (Holding cost per unit per year)

Order quantity
= (Holding cost per unit per year)
2

Q
= (H)
2

50
 The EOQ Model
Order quantity, Q
Demand Average
rate inventory
Inventory Level

Q
2

Reorder point, R

Lead Time
time
Order Order
placed receipt

51
 The EOQ Model
Q = Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
O = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year

Optimal order quantity is found when annual

ordering/setup cost equals annual holding cost

D Q
O = H
Q 2
Solving for Q*
2DO = Q2H
Q2 = 2DO/H
Q* = 2DO/H

52
Example
 ABC hospital uses 1,000 painless hypodermic
needles per year. The hospital would like to
determine the optimum number of needles to
obtain per order from its major supplier. It
costs the company $10 to release an order for
hypodermic needles, and $0.50 per needle
per year to hold in inventory.
 Compute:
 a) the EOQ for the hypodermic needles.
 b) the optimum number of orders per year.
 c) the time between orders (optimum order cycle
time) given the hospital operates for 250 days per
year.
 d) the sum of the minimum annual carrying and
ordering costs.
53
Solution
Given:
D = 1,000 units
O = $10 per order
H = $.50 per unit per year

A) Determine optimal number of needles to order

2DO
EOQ = Q* =
H

2(1,000)(10)
Q* = = 40,000 = 200 units
0.50
54
An EOQ Example
B) Determine optimal number of orders per year
Q* = 200 units

Expected Demand D
number of = N = =
orders Order quantity Q*

1,000
N= 200 = 5 orders per year

55
 An EOQ Example
C) Determine optimal time between orders (optimal order Cycle Time)

Number of working
Expected days per year
time =T= N
between
orders
250
T= = 50 days between orders
5

56
 An EOQ Example
D) Determine the sum of the minimum annual carrying and
ordering costs

Total annual cost = Setup (Ordering) cost + Holding cost

D Q
TC = O + H
Q 2
1,000 200
TC = ($10) + ($.50)
200 2
TC = (5)($10) + (100)($.50) = $50 + $50 = $100

57
 Exercise 1
The Sofaworld Company purchases 100,000 logs
per year and pays birr 1,000 per log. The company
also operates for 250 days per year. The company
incurs birr 1,600 to process an order and 15% of
the unit price for annual holding cost per log.
 Answer Key:
A. How many logs the company  A. 1,460.59 logs
should optimally order?  B. Birr 219,089
B. Compute the sum of the  C. 68.47 orders
minimum annual ordering and  D. 3.65 days
holding cost.
C. Determine the optimum number
of order per year.
D. Compute optimal time between
orders.
58
 Exercise 2
 By next year, a local distributor of BridgeStone
tire expects to sell approximately 9,600 steel
belted radial tires of a certain size and tread
design. For each tire, the distributor pays $160 to
the manufacturer. Annual carrying cost per tire is
estimated to be10% of the unit price of tire, and
ordering cost is $75 per order. The distributor also
operates 288 days a year.
a) What is the EOQ?
b) How many times per year does the store reorder?
c) What is the total annual cost if the EOQ quantity is
ordered?
d) Compute time between orders .
 AK: a. 300tires. b. 32. c.Br.4800. d. 9days.
59
4.6 Production Order Quantity
Model
 Used when;
 the assumption in EOQ model that
Q is received all at once is relaxed.
 receipt of order is non-
instantaneous.
 inventory builds up over a period
of time after an order is placed.
 units are produced and sold or
consumed simultaneously.
60
Production Order Quantity Model

61
 Production Order Quantity Model
Q= Number of pieces per order p = Daily
production rate
H= Holding cost per unit per year d=
Daily demand/usage rate
Maximum
t= =
Length Total
of theproduced Total used
production run– in days
inventory during the during the
level = pt –production
dt run production run

However, Q = total produced = pt ; thus t = Q/p

Maximum = p Q
–d
Q
=Q 1–
d
inventory p p p
level

62
 Production Order Quantity Model

Average
= (Maximum inventory level)/2
inventory level

Maximum inventory Q d
Annual Holding cost = 2 (H) p
= 1
level
– H
2

63
/
Q= Number of pieces per order p= Daily
production rate
H= Holding cost per unit per year d= Daily
demand/usage rate
D= Annual demand
Setup cost =(D/Q)S
1
Holding cost = 2 HQ[1 - (d/p)]

(D/Q)S = 1 HQ[1 - (d/p)]

2
2DS
Q =
2
H[1 - (d/p)]
2DS
Q* = H[1 - (d/p)]
p
64
Example
 Assume Nifas Silk Paints Factory started to
sell iron coat paint produced using its own
store. Nifas Silk Paints Factory produces
iron coat paint at a daily rate of 150
gallons. The store owned by the factory
operates for 311 days a year. The factory
wants to determine the optimal production
quantity for the iron coat paint given that
annual demand of 10,000 gallons, annual
carrying cost of birr 0.75 per gallon, and
set up cost of birr 150 per order.

65
Example
 Compute:
a) the EPQ (Economic Run size) for the iron coat
paint
b) the sum of the minimum annual carrying and
setup costs
c) the production run time
d) the optimum number of production runs per
year
e) maximum inventory
f) cycle time
g) idle time

66
Solution
H = birr0.75 per gallon per year S = birr150 per order

D = 10,000 gallons
d = 10,000/311 = 32.2 gallons per day
p = 150 gallons per day

Qopt = 2SD = 2(150) = 2,256.8

d (10,000)
32.
gallons
a H 1- p 2
) 0.75 1 - 150

b) TC = SD HQ d
Q + 2 1- p

150(10,000) 0.75 32.

TC = 2,256.8 +(2,256.8) 2
1- 15
2
= birr 664.7 + birr 664.6
67 0
= birr 1,329.3
 Production Order Quantity Example
c) Production run timeQ= 2,256.8
= = 15.05 days
per order p 150

d)
D 10,000
Number of production runs = = = 4.43 runs/year
Q 2,256.8
e)
d 32.2
Maximum inventory level = Q 1 - = 2,256.8 1 -
p 150
= 1,772 gallons

68
Production Order Quantity Model

f) Cycle time = Q/d = 2256.8/32.2 = 70.09

days
g) Idle time = CT-PT = 70.09- 15.05 =
55.04 days

69
Exercise 1
 A plant manager of a chemical plant must
determine the lot size for a particular
chemical that has a steady demand of 30
barrels per day. The production rate is 190
barrels per day, annual demand is 10,500
barrels, setup cost is $200, annual holding
cost is $0.21 per barrel, and the plant
operates 350 days per year.

70
Exercise 1

Determine: Answer Key

a. The economic production a. 4,873.4

lot size (ELS or EPQ). barrels.
b. The minimum total b. $861.82.
annual setup and c. 162.4, or 162
inventory holding cost for days.
this item. d. 25.6, or 26
c. The time between orders days.
(TBO), or cycle length, for
the ELS.
d. The production time per
lot.
71
Exercise 2
 The DP Corporation is both a producer and a user of brass couplings.
The firm operates for 220 days a year and uses the couplings at a
steady rate of 50 per day. Couplings can be produced at rate of 200 per
day. Annual holding cost is $2 per coupling, and machine setup cost is
$70 per production run.

 Compute:  AK
a. The EPQ (Economic Run size) for the
Couplings. a. 1,014
couplings.
b. The optimum production run time.
b. 5.07days.
c. The optimum number of production runs
per year. c. 97.13 runs.
d. Average inventory. d. 379.88
e. The size of couplings used during couplings.
production time. e. 253.5
f. The length of the pure consumption couplings.
portion of the cycle time (idle time). f. 15.2 days.
72
4.7. Quantity Discount Model
 Quantity discounts are price
incentives to purchase large
quantities which create pressure to
maintain a large inventory.
 In the quantity discount model, the
item’s price is no longer fixed, as
assumed in the basic EOQ model.
 If the order quantity is increased
enough, the price is discounted.

73
Quantity Discount Models
 Quantity discount model
 requires a new approach to find the best
order/lot size.
 one that balances the advantages of
lower prices for purchased materials
and fewer orders (which are benefits of
large order quantities) against the
disadvantage of the increased cost of
holding more inventory.

74
Quantity Discount Models
 The total annual cost now includes not only the
 holding cost and the ordering cost, but also
 the cost of purchased materials.

Total cost = Annual Ordering Cost + Annual

Holding Cost + Annual Purchasing Cost
D Q P = per unit price of the item
TC = O+ H + PD
D = annual demand
Q 2
H = annual carrying cost per unit
O = ordering cost per order
Q = order quantity per order
75
 Example 1
Quantity discount model example when annual
holding/carrying cost is expressed as a percentage
of unit price (variable holding cost per unit).
• A manufacturing firm has been offered a particular
component part it uses according to the following discount
pricing schedule from one of its suppliers

Discount Discount
Number Discount Quantity Discount (%) Price (P)

1 0 to 999 no discount $5.00

2 1,000 to 1,999 4 $4.80

3 2,000 and over 5 $4.75

76
 Quantity Discount Example 1

• Additional information:
– inventory carrying cost per unit per year
(H) = IP = 20% of unit price
– Ordering cost per order (O) = $49
– Annual demand for the component (D) = 5,000
units

77
 Quantity Discount Example 1

Steps in analyzing a quantity discount

Step 1: For each discount, calculate EOQ*

2DO 2(5000)(49)
Q$5 = = = 700 units
H 0.2(5)

2DO 2(5000)(49)
Q$4.8 = = = 714 units
H 0.2(4.8)

2DO 2(5000)(49)
Q$4.75 = = =
H 0.2(4.75)
718 units
78
Step 2: Check Feasibility of Order
Quantities
 Next, we analyze the order quantities we computed.
 We see that EOQ* for the discounts are infeasible since they do
not fall in the range of 1,000 units and above.
 In other words, a discounted rate of $4.80 and $4.75 are offered
only if the order sizes are in the range of 1,000 upto1,999 units as
well as in the range 2,000 units and above, respectively.
 However, the EOQs* we computed for purchase price of $4.80 and
$4.75 are less than 1000, and hence they are considered
infeasible.
 We, therefore, adjust the minimum value of EOQ $4.80 to 1000 units
(from 714 units) as well as the minimum value of EOQ $4.75 to 2,000
units (from 718 units).
 Table below summarizes the feasibility of the order quantities for
each purchase price as well as the adjusted order quantity
(adjusted EOQs).
 The EOQ for purchase price of $5.00 is in the feasible range, and
no adjustment is required.
79
Table: Feasibility Check
Purchase Order Feasible Adjusted
price quantity EOQ
$5.00 700 Yes -
$4.80 714 No 1000
$4.75 718 No 2000

80
 Step 3: Determine TIC

We next compute TIC for EOQ$5.00 ,

EOQ$4.80, and EOQ$4.75 using the following
the formula:
SD HQ
TC = + + PD
Q 2

Annual Annual Annual

Discount Unit Order Purchasi Ordering Holding
Number Price Quantity ng Cost Cost Cost Total
1 $5.00 $25,000 $350 $25,700
700 $350
2 $4.80 $24,000 $480 $24,725
1,000 $245

813 $4.75
2,000
$23.750
$122.50
$950 $24,822.50
Step 4: Determine Optimal Order
Size
 Table above summarizes the results of this
problem including TIC values for each option.
 Notice that the TIC$4.80 is less than both
TIC$5.00 and TIC$4.75.
 The order quantity corresponding to TIC$4.80
is 1000 units.
 Thus, we conclude that it is best to order 1000
units each time we place an order.
 Figure 4.2 illustrates the price curves and
optimal order quantity for this multiple price-
break model.

82
Summary of All-Units Discount
(Instantaneous Supply)Solution Procedure
 Following is a summary of the all-units discount
solution procedure:
a. For each unit cost value, use the basic EOQ
formula to compute the economic order quantity.
b. If the EOQ value computed falls in the feasible
range, compute the TIC. If the EOQ does not fall in
the feasible range, adjust the EOQ such that it
falls in the feasible range. Compute the TIC using
this adjusted EOQ value.
c. Compare the TIC values for all such feasible EOQ
values. The EOQ value which corresponds to the
minimum TIC is the optimal quality under all-unit
discount.
83
Example 2
• Steps When annual inventory holding cost
per unit is constant:
1. Compute the EOQ and find which price range it
falls in.
2. If that quantity is valid for the lowest price
range, it is the optimal.
3. If it falls in a range associated with a higher
unit price, compute the total cost using that
price and the total cost for the minimum
quantity needed to qualify for a lower unit
price.
4. The quantity (valid or price break) that
produces the lowest total cost is the optimum.
84
 Quantity Discount Example 2
QUANTITY PRICE S= $2,500
1 - 49 $1,400 H= $190 per TV
50 - 891,100 D= 200 TVs per year
90+ 900

2CoD 2(2500)(200)
EOQ = = = 72.5 TVs
Cc 190
For Q = 72.5 SD HQ
TC = + 2 + PD
Q

2,500(200) 190(72.5)
TC = + + 1,100(200) = $233,784
72.5 2
85
 Quantity Discount Example 2

For Q = 90
SD HQ
TC = + + PD =
Q 2

2,500(200) 190(90)
TC = + + 900(200) = $194,105
90 2

Decision: take the maximum discount price, order

at least 90 TVs, and the total cost will be
$194,105
86