Annual demand for a product is 40,000 units. The product is used at a constant rate over the 365 days the company is open every year. The annual holding cost for the product is estimated to be $2.50 per unit and the cost of placing each order is $125.00. If the company orders according to the economic order quantity (EOQ) formula, then its total annual inventory cost for this product would be
A) $100,000
B) $50,000
C) $5,000
D) $2,500

Question

Quizplus · Accepted Answer

The total annual inventory cost using the EOQ model is the sum of the ordering cost and the holding cost. The EOQ formula is used to minimize these costs. The EOQ is calculated as √((2 * Demand * Order Cost) / Holding Cost). Substituting the given values, EOQ = √((2 * 40,000 * 125) / 2.5) = 2,000 units. The total cost is then (Demand/EOQ * Order Cost) + (EOQ/2 * Holding Cost) = (40,000/2,000 * 125) + (2,000/2 * 2.5) = $2,500 + $2,500 = $5,000.

Annual Demand for a Product Is 40,000 Units