15 Deterministic EOQ Inventory Models

# 15 Deterministic EOQ Inventory Models - Deterministic EOQ...

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± ± ± ± ± ± ± ± ± ± ± Deterministic EOQ Inventory Models In this chapter, we begin our formal study of inventory modeling. In earlier chapters, we de- scribed how linear programming can be used to solve certain inventory problems. Our study of inventory will continue in Chapters 16, 18, and 19. We begin by discussing some important concepts of inventory models. Then we develop versions of the famous economic order quantity (EOQ) model that can be used to make op- timal inventory decisions when demand is deterministic (known in advance). In Chapters 16 and 19, we discuss models in which demand is allowed to be random. 15.1 Introduction to Basic Inventory Models To meet demand on time, companies often keep on hand stock that is awaiting sale. The purpose of inventory theory is to determine rules that management can use to minimize the costs associated with maintaining inventory and meeting customer demand. Inventory models answer the following questions. (1) When should an order be placed for a prod- uct? (2) How large should each order be? Costs Involved in Inventory Models The inventory models considered in this book involve some or all of the following costs. Ordering and Setup Cost Many costs associated with placing an order or producing a good internally do not de- pend on the size of the order or on the production run. Costs of this type are referred to as the ordering and setup cost. For example, ordering cost would include the cost of pa- perwork and billing associated with an order. If the product is made internally rather than ordered from an external source, the cost of labor (and idle time) for setting up and shut- ting down a machine for a production run would be included in the ordering and setup cost. Unit Purchasing Cost This is simply the variable cost associated with purchasing a single unit. Typically, the unit purchasing cost includes the variable labor cost, variable overhead cost, and raw ma- terial cost associated with purchasing or producing a single unit. If goods are ordered from an external source, the unit purchase cost must include shipping cost.

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15.1 Introduction to Basic Inventory Models 847 Holding or Carrying Cost This is the cost of carrying one unit of inventory for one time period. If the time period is a year, the carrying cost will be expressed in dollars per unit per year. The holding cost usually includes storage cost, insurance cost, taxes on inventory, and a cost due to the pos- sibility of spoilage, theft, or obsolescence. Usually, however, the most signiﬁcant compo- nent of holding cost is the opportunity cost incurred by tying up capital in inventory. For example, suppose that one unit of a product costs \$100 and the company can earn 15% annually on its investments. Then holding one unit in inventory for one year is costing the company 0.15(100) ± \$15. When interest rates are high, most ﬁrms assume that their an- nual holding cost is 20%–40% of the unit purchase cost.
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15 Deterministic EOQ Inventory Models - Deterministic EOQ...

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