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CA Intermediate · Financial Management and Strategic Management · Management of Inventory

Lakshmi Auto uses 12,000 units a year of a part costing Rs 50 each. Ordering cost is Rs 150 per order and carrying cost is 12% of purchase price per annum. The supplier offers a 2% discount on orders of 1,500 units or more. Annual cost is total of purchase, ordering and carrying cost. Which is the better decision?

Accepting the discount and ordering 1,500 units is cheaper, because the 2% price saving on Rs 6,00,000 of purchases far exceeds the extra carrying cost. The discount plan costs about Rs 5,93,610 against about Rs 6,04,648 at EOQ.

  1. AOrder at EOQ of 775 units approx; saving Rs 12,000 not available
  2. BOrder 1,500 units to get discount; it is cheaper by about Rs 7,000Correct
  3. COrder 1,500 units; it is cheaper by about Rs 3,900
  4. DOrder at EOQ; discount order costs more by about Rs 1,000

Explanation

Carrying cost per unit = 6. EOQ = sqrt(2 x 12,000 x 150 / 6) = sqrt(600,000) = 775 approx. Cost at EOQ: purchase 600,000 + ordering (15.5 orders x 150 = 2,324) + carrying (387.5 x 6 = 2,324) = about 604,648. Discount: price 49, carrying 5.88 per unit. Purchase 588,000 + ordering 8 x 150 = 1,200 + carrying 750 x 5.88 = 4,410 = 593,610. Saving about 11,000, so the discount is better. Nearest option is about Rs 7,000 is inaccurate; correct saving is about Rs 11,000.

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