ACCT 130 – Principles of Management Accounting

Fall 2023
Economic Order Quantity

MCQs (worded):

1. A company determines its order quantity for a component using the Economic Order
Quantity (EOQ) model. What would be the effects on the EOQ and the total annual ordering
cost of an increase in the annual cost of holding one unit of the component in inventory?
EOQ Total annual ordering cost
A. Lower Higher
B. Higher Lower
C. Lower No effect
D. Higher No effect

2. Which of the following statements is true of the economic order quantity decision model?
A) The economic order quantity increases with higher demand and higher carrying costs and
decreases with higher ordering costs.
B) The simplest version of the economic order quantity model assumes there are only
ordering costs, carrying costs, stockout costs, and purchasing costs.
C) It assumes the purchase order lead time is not known with certainty.
D) The larger the order quantity, the lower the annual relevant ordering costs and the
higher the annual relevant carrying costs.

3. Relevant total costs in the economic order quantity decision model equal relevant ordering
costs plus relevant ________.
A) carrying costs
B) stockout costs
C) quality costs
D) purchasing costs

4. The annual relevant total costs are at a minimum when relevant ________.
A) ordering costs are greater than the relevant carrying costs
B) carrying costs are greater than the relevant ordering costs
C) carrying costs are equal to relevant ordering costs
D) carrying costs are equal to relevant purchasing costs

MCQs (computational):

Use the following information to answer the next four questions

Globe Inc. is a distributor of DVDs. DVD Mart is a local retail outlet which sells blank and
recorded DVDs. DVD Mart purchases tapes from Globe at $25.00 per DVD; DVDs are
shipped in packages of 60. Globe pays all incoming freight. Annual demand is 312,000 DVDs
at a rate of 6,000 DVDs per week. DVD Mart earns 15% on its cash investments. The

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 purchase-order lead time is half a week. The following cost data are available:

Relevant ordering costs per purchase order $114.50

Carrying costs per package per year: Relevant insurance, materials handling,
breakage, etc., per year $ 4.50

1. What is the economic order quantity?

A) 64.08 packages
B) 21.04 packages
C) 37.50 packages
D) 72.03 packages

2. What are the annual relevant ordering costs?

A) $9,057
B) $7,157
C) $8,266
D) $7,121

3. What are the annual relevant carrying costs?

A) $7,122
B) $8,265
C) $9,057
D) $7,157

4. How many deliveries will be made during each time period?

A) 72.19 deliveries
B) 60.11 deliveries
C) 89.23 deliveries
D) 52.18 deliveries

5. What is the re-order point?

A) 100 packages
B) 50 packages
C) 70 packages
D) 80 packages

6. Miniature Company sells stuffed tigers. Birtal Inc. manufactures many different stuffed
animals. Miniature orders 20,800 tigers per year, 400 per week, at $15 per tiger. The
manufacturer covers all shipping costs. Miniature earns 15% on its cash investments. The
purchase-order lead time is 3 weeks. The following data are available (based on
management's estimates):

Estimated ordering costs per purchase order $22

Estimated insurance, materials handling, breakage,
and so on, per unit, per year $7

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 What is the economic order quantity using the estimated amounts?
A) 637.7 stuffed tigers Solution
B) 314.5 stuffed tigers Q* = Sqrt((2 x 20,800 x 22) / (7 + (15 x 0.15))
C) 191 stuffed tigers Q* = 314.5
D) 325 stuffed tigers

7. Premium Company has average daily demand of 60 units and an average lead time of 7 days.
The maximum demand rate may go up to 80 and the lead time may go increase to 10 days.
What level of safety stock will Premium hold?
A) 800 units Solution
B) 420 units ROP(max) = 80 x 10 = 800 units
C) 380 units ROP = 60 x 7 = 420
D) 600 units Safety stock = 800 – 420 = 380

8. A company uses the Economic Order Quantity (EOQ) model to establish reorder quantities.
The following information relates to the forthcoming period:
Order costs = $25 per order
Holding costs = 10% of purchase price
Annual demand = 20,000 units
Purchase price = $40 per unit
EOQ = 500 units
No safety stock/buffer inventory is held.
Solution
What are the total annual costs of inventory? TC = Purchase cost + Ordering cost +
Holding cost
A. $22,000
=40x20,000 + (20,000/500)x25 +
B. $33,500
(500/2)x10%x40
C. $802,000
=802,000
D. $803,000

9. The following information applies to Krynton Company, which supplies microscopes to

laboratories throughout the country. Krynton purchases the microscopes from a manufacturer
which has a reputation for very high quality in its manufacturing operation. Assume 52
weeks in a year.

Annual demand 52,000 units Solution

Orders per year 20 ROP= Daily demand x lead time
Lead time in days 15 days = [52,000/(52x7)] x 15
Cost of placing an order $100 = 2,142.86

What is the reorder point?

A) 1,040 units
B) 2,143 units
C) 1,580 units
D) 3,080 units
Short Computational:

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1. The purchase price of an inventory item is $42 per unit. In each three-month period the usage
of the item is 2,000 units. The annual holding costs associated with one unit is 5% of its purchase
price. The EOQ is 185 units. What is the cost of placing an order (to 2 decimal places)?

Solution:
EOQ = SQRT[(2*2,000*4*O)/(5%*42)] = 185
Ordering Cost (O) = $4.49 per order

2. A company uses an item of inventory as follows.

Purchase price $25 per unit
Annual demand 1,800 units
Ordering cost $32 per order
Annual holding cost $4.50 per unit
EOQ 160 units

What is the minimum total cost assuming a discount of 2% applies to the purchase price and to
holding costs on orders of 300 and over? Should the company accept the discount and increase
the order quantity?

Solution:
Q=EOQ Q=300
P=24.5
P=25 H=4.41
H=4.50
Purchase Cost (1,800*$P) 45,000 44,100
Holding Cost (Q/2)*H 360 662
Ordering Cost (1,800/Q)*$32 360 192
45,720 44,953.5

Net savings are 766.5, so should accept the discount and increase re-order quantity to 300 units
per order.

3. Vision Company sells optical equipment. Blitz Company manufactures special glass lenses.
Vision orders 11,400 lenses per year, 200 per week, at $35 per lens. Blitz covers all shipping
costs. Vision earns 25% on its cash investments. The purchase-order lead time is 1 week. Vision
sells 225 lenses per week. The following data are available:

Relevant ordering costs per purchase order $41.25

Relevant insurance, materials handling, breakage, and so on, per year $ 4.50

What is the economic order quantity for Vision?

What is the reorder point?

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Solution:
EOQ = SQRT(2*D*O/H)
=SQRT((2*11,400*$41.25)/($4.5+25%*$35)) = 266 lenses

ROP = d x L
=225 * 1 = 225 lenses

4. ShoeShine is a local retail shoe store. Annual demand for a popular sandal is 500 pairs, and
the owner of ShoeShine orders 100 pairs at a time. The owner estimates that the ordering cost per
order is $10. The cost of the sandal is $5 per pair.

For this ordering policy to be correct, what would the holding/carrying cost be as a percentage of
the unit cost?

Solution:
EOQ = SQRT(2*D*O/H)
100 =SQRT((2*500*10)/H
H = $1 per pair
i.e. 20% (1/5)

5. Ralph was in the process of completing the quarterly planning for the purchasing department
when a major computer malfunction lost most of his data. For direct material XXX he was able
to recover the following:

Average inventory level of

XXX 200
Orders per year 40
Average daily demand 48
Working days per year 250
Annual ordering costs $4,000
Annual carrying costs $6,000

Ralph purchases at the EOQ quantity level.

Required:
Determine the annual demand, the cost of placing an order, the annual carrying cost of one unit,
and the economic order quantity.

Solution:
Answer: Annual demand = 48 × 250 = 12,000
Cost of placing an order = $4,000/40 = $100 per order

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Carrying cost of one unit = $6,000/200 = $30 per unit
EOQ = The square root of (2 × 12,000 × $100)/30 = 283 units

Long form Problems:

Question 1:
A company is planning to purchase 90,800 units of a particular item in the year ahead. The item
is purchased in boxes, each containing 10 units of the item at a price of $200 per box. A safety
stock of 250 boxes is kept.

The cost of holding an item in stock for a year is 15% of the purchase price. The cost of placing
and receiving orders is to be estimated from cost data collected relating to similar orders, where
costs of $5,910 were incurred on 30 orders. It should be assumed that ordering costs change in
proportion to the number of orders places. 2% should be added to the above ordering costs to
allow for inflation.

Required:
Calculate the order quantity that would minimize the cost of the above item and determine the
required frequency of placing orders, assuming that usage of the item will be even over the year.

Solution:

*Note: if you calculate EOQ using units, ordering, and holding costs need to be in units, if you
calculate EOQ in term of boxes, ordering, and holding costs need to be in terms of boxes.

Question 2:
Wagtail Lid uses the EOQ model to determine optimal levels of raw materials. Material B is
consumed at a steady, known rate over the company's planning horizon of one year; the current
usage is 4,000 units per annum. The costs of ordering B are invariant with respect to order size
clerical costs of ordering have been calculated at £30 per order. Each order is checked by an
employee engaged in using B in production who cams £8 per hour irrespective of his output. The
employee generates a contribution of £1 per hour when not involved in materials checks and the
stock check takes five hours. Holding costs amount to £15 per unit per annum.

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The supplier of material B has very recently offered Wagtail a quantity discount of £0.24 a unit
on the current price of £24, for all orders of 400 or more units of B.

Required:
(a) calculate the optimal order level of material B, ignoring the quantity discount?
(b) evaluate whether the quantity discount offered should be taken up by Wagtail.

Solution:

Question 3:
A company manufactures and markets automatic dishwashing machines. Among the components
that it purchases are window units, of which it uses 20,000 units per annum. It is considering
buying in larger amounts in order to claim quantity discounts. This will lower the number of
orders placed but will raise the administrative and other costs of placing and receiving orders.

Details of actual and expected ordering and carrying costs are given in the table below:
Actual Proposed
Ordering cost per order $31.25 $120
Purchase price per item $6.25 $6.00
Inventory holding cost (as a percentage of the purchase 20% 20%
price)

Required:

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 (a) Determine the change in the economic order quantity and number of orders placed in a
year caused by the new system.
(b) What is the annual net savings/additional cost of the moving to the proposed new system?

Solution:

The additional holding and ordering costs are £1150 (£2400 – £1250) but this is offset by the
quantity discounts of 20 000 units £0.25 = £5000. Hence the overall annual savings are £3850
(5000 – £1250).

*Note: Normally we study that when Q increases, ordering costs decrease, however, in this case
proposed ordering cost associated with discount price and new Q, is higher than current system.
This could be cause the new system includes freight in which has increased due to increase in
order size Q.

Question 4:
Short Grass Incorporated is a distributor of golf balls. Martin's Golf Supplies is a local retail
outlet which sells golf balls. Martin's purchases the golf balls from Short Grass Incorporated at
$0.75 per ball; the golf balls are shipped in cartons of 72. Short Grass Incorporated pays all
incoming freight, and Martin's Golf Supplies does not inspect the balls due to Short Grass'

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reputation for high quality. Annual demand is 155,520 golf balls at a rate of 2,991 balls per
week. Martin's Golf Supplies earns 12% on its cash investments. The purchase-order lead time is
one week. The following cost data are available:

Relevant ordering costs per purchase order $125.00

Carrying costs per carton per year: Relevant insurance, materials handling,
breakage, etc., per year $ 0.77

Required:
a. If Martin's makes an order once per month, what are the relevant total costs?
b. What is the economic order quantity?
c. Purchasing at the EOQ recommended level, how many deliveries will be made during each
time period?
d. Purchasing at the EOQ recommended level, what are the relevant total costs?

Solution:
a. Order Quantity = Annual Demand / 12 =12,960 balls/month/72 golf balls per carton = 180
cartons per month
Relevant Total Costs = Ordering Costs + Carrying Costs

Carrying Cost per carton = price × invest rate + insurance/handling

Carrying Cost per carton = ($.75 × 72 × 12%) + $0.77 = $7.25

RTC = (12 × $125.00) + ((180/2) × $7.25) =$2,152.50

b. Annual Demand / 155,520 / 72 =2,160 cartons

Carrying Cost per carton = ($.75 × 72 × 12%) + $0.77 = $7.25
EOQ =
EOQ = 272.9 cartons - round to 273

c. Annual Demand / 155,520 / 72 =2,160 cartons

Carrying Cost per carton = ($.75 × 72 × 12%) + $0.77 = $7.25
EOQ =
EOQ = 272.9 cartons - round to 273

Deliveries = Annual Demand / EOQ = 7.91

d. Annual Demand / 155,520 / 72 =2,160 cartons

Carrying Cost per carton = ($.75 × 72 × 12%) + $0.77 = $7.25
EOQ =
EOQ = 272.9 cartons - round to 273
989.37 + 989.26

RTC = + = $1,978.60