Annual demand for a product costing Rs. 100 per piece is Rs. 900. Orde...
Calculation of Economic Lot Size
Gathering the Given Data
- Cost per piece (C) = Rs. 100
- Annual demand (D) = Rs. 900
- Ordering cost per order (S) = Rs. 100
- Inventory holding cost (H) = Rs. 2 per unit per year
Calculation of Economic Lot Size
The formula to calculate the economic lot size is:
Economic Lot Size = √(2DS/H)
By substituting the given data in the formula:
Economic Lot Size = √(2 × 100 × 900/2) = √(90000) = 300
Explanation of Economic Lot Size
The economic lot size is the optimal quantity of units that a company should order to minimize the total cost of ordering and holding inventory. In this case, the economic lot size is 300 units. This means that the company should order 300 units of the product at a time to minimize the total cost of ordering and holding inventory.
By ordering 300 units at a time, the company will incur an ordering cost of Rs. 100 per order. Since the annual demand is Rs. 900, the company will place 3 orders in a year. The total ordering cost will be Rs. 300.
The company will also incur a holding cost of Rs. 2 per unit per year. Since the company is ordering 300 units at a time, the average inventory will be 150 units. The total holding cost will be Rs. 300.
Therefore, the total cost of ordering and holding inventory will be Rs. 600 (Rs. 300 for ordering and Rs. 300 for holding). This is the minimum total cost that the company can achieve by ordering 300 units at a time.