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Optimum Order Quantity - EOQ Analysis

Tiger Corp purchases 1,200,000 units per year of one component. The fixed cost per order is $25. The annual carrying cost of the item is 27% of its $2 cost.

a) Determine the EOQ under each of the following conditions: (1) no changes, (2) order cost of zero, and (3) carrying cost of zero.

b) What do your answers illustrate about the EOQ model? Explain?

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Solution Preview

Finding the optimum order quantity in the above example, Q= SQRT(2CD/H), we find:

a) (1) with no changes, Q=SQRT(2CD/H)=SQRT(2(25)(1,200,000)/$0.54)=10,540 units
(2) order cost of zero, Q=SQRT(2CD/H)=SQRT(2(0)(1,200,000)/$0.54)=0 units
(3) carrying cost of zero, Q=SQRT(2CD/H)=SQRT(2(25)(1,200,000)/$0.00)=Undefined or Infinity

b) The answers from part a illustrate that the EOQ model isn't perfect in practice as it is a mathematical equation subject to certain limitations. For example, the optimum order quantity under normal circumstances (part 1) came to 10,540 units. For part 2, we used an order cost of zero which made the numerator zero rendering the answer zero. Again, in part 3 we ...

Solution Summary

The solution calculates the EOQ for a product under varying conditions and explains some of the inferences about the EOQ that can be made as a result of the calculations.