Write out the formula for the total costs of carrying and ordering inventory, and then use the formula to derive the EOQ model.
Andria Mullins, financial manager of Webster Electronics, has been asked by the firm’s CEO, Fred Weygandt, to evaluate the company’s inventory control techniques and to lead a discussion of the subject with the senior executives. Andria plans to use as an example one of Webster’s “big ticket” items, a customized computer microchip that the firm uses in its laptop computers. Each chip costs Webster $200, and in addition it must pay its supplier a $1,000 setup fee on each order. Further, the minimum order size is 250 units. Webster’s annual usage forecast is 5,000 units, and the annual carrying cost of this item is estimated to be 20% of the average inventory value.
Andria plans to begin her session with the senior executives by reviewing some basic inventory concepts, after which she will apply the EOQ model to Webster’s microchip inventory.