Calculating Production Runs
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Details: You have just met with the Director of Purchasing. He has been attempting to reduce his costs by placing fewer, but larger, orders for raw materials. You suspect that his department's actions have been contributing to your organization's high COS.
Your assignment is to calculate the EOQ/ELS for the following two cases. Include your full calculations:
Raw Material LRM:
Annual demand has historically been about 15,000 units. Each unit costs about $40. For the annual report, due out in June, the corporate accounting department calculates inventory-holding costs by multiplying the value of each item by 0.40. The Director of Purchasing told you that his "cost of ordering" is about $82 per order. He is currently ordering 1,000 at a time. How large should the standard order size be for this product? How much are the Purchasing Director's policies costing your company? (Calculate the ordering and holding costs associated with his policies and compare them to the "optimal" ordering and holding costs.)
Finished Product CLM:
Annual demand has historically been about 5,700 units. The sales price for each unit of CLM is about $48. The production line that produces CLM can make 100 units per day, but it currently has 170 days per year devoted to manufacturing another project?assume 250 total production days per year. The setup cost for product CLM averages $500 per setup. How large should the production runs be for CLM?
Objective: ? Apply the appropriate operations tools to aid in decision-making and optimize performance
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Solution Summary
This problem provides details on calculating production runs for purchasing department given annual demand, unit cost and setup cost using EOQ model.
Solution Preview
The standard order size should be calculated using the formula for EOQ, derived using basic EOQ model assumptions. This model is chosen for calculations of EOQ because the data follows all the requirements of the basic EOQ model.
Basic EOQ model assumptions are as follows:
? Demand Rate is deterministic and is constant over time.
? Instantaneous replenishment i.e. Rate of replenishment is infinite.
? Lead time and other system parameters such as costs are constant, independent of replenishment quantity and are known with certainty
? Shortages of stock are not allowed. I.e. C3 = 0.
? Acquisition cost is fixed, i.e., no quantity discounts
CALCULATIONS:
D=15000 units
Unit cost, C=$40
Holding cost rate= 0.4 of C
Holding cost, C1= 0.40*40 = $16 per unit per year.
Ordering cost, C2=$82 per order
Economic order quantity =
EOQ for LRM = = 392.11 units
EOQ for LRM= 392.11 units
To calculate the Optimal ordering cost, we need number of orders/year
Number of orders/year for EOQ= = 38.25 orders/year
Annual Ordering cost= Number of orders/year * C2 = 38.25*$82 ...
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