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    Quantity Discounts Model

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    scribdghayas
    This document discusses how to apply the economic order quantity (EOQ) model when quantity discounts are available from suppliers. It presents a three-step process: 1) Calculate a preliminary EOQ for each discount level. 2) Adjust order quantities up if needed to meet discount thresholds. 3) Compute total annual costs for each quantity using the appropriate discount, and select the minimum cost option. An example applies these steps and finds that ordering 1000 units at a 3% discount minimizes total annual costs, even though a higher 5% discount is available at 2500 units due to increased holding costs.

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    Quantity Discounts Model

    Uploaded by

    scribdghayas
    2K views15 pages
    This document discusses how to apply the economic order quantity (EOQ) model when quantity discounts are available from suppliers. It presents a three-step process: 1) Calculate a preliminary EOQ for each discount level. 2) Adjust order quantities up if needed to meet discount thresholds. 3) Compute total annual costs for each quantity using the appropriate discount, and select the minimum cost option. An example applies these steps and finds that ordering 1000 units at a 3% discount minimizes total annual costs, even though a higher 5% discount is available at 2500 units due to increased holding costs.

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    Operations Research: Quantity Discounts Model

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    This document discusses how to apply the economic order quantity (EOQ) model when quantity discounts are available from suppliers. It presents a three-step process: 1) Calculate a preliminary EOQ for each discount level. 2) Adjust order quantities up if needed to meet discount thresholds. 3) Compute total annual costs for each quantity using the appropriate discount, and select the minimum cost option. An example applies these steps and finds that ordering 1000 units at a 3% discount minimizes total annual costs, even though a higher 5% discount is available at 2500 units due to increased holding costs.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    2K views15 pages

    Quantity Discounts Model

    Uploaded by

    scribdghayas
    This document discusses how to apply the economic order quantity (EOQ) model when quantity discounts are available from suppliers. It presents a three-step process: 1) Calculate a preliminary EOQ for each discount level. 2) Adjust order quantities up if needed to meet discount thresholds. 3) Compute total annual costs for each quantity using the appropriate discount, and select the minimum cost option. An example applies these steps and finds that ordering 1000 units at a 3% discount minimizes total annual costs, even though a higher 5% discount is available at 2500 units due to increased holding costs.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    of 15

    EOQ MODEL WITH QUANTITY DISCOUNTS

    Quantity discounts occur in numerous situations in


    which suppliers provide an incentive for large order
    quantities by offering a lower purchase cost when
    items are ordered in larger quantities.

    Here we discuss how EOQ model can be used


    when quantity discounts are available.

    Assume that we have a product in which the basic


    EOQ model is applicable.
    EOQ MODEL WITH QUANTITY DISCOUNTS

    Instead of a fixed unit cost, the supplier quotes the


    following discount schedule:,
    EOQ MODEL WITH QUANTITY DISCOUNTS

    The 5% discount for the 2500-unit minimum order


    quantity looks tempting.

    But considering that higher order quantities result in


    higher inventory holding costs, we should prepare a
    thorough cost analysis before making a final
    ordering and inventory policy recommendation.

    Suppose that the data and cost analyses show;


    - an annual holding cost rate of 20%,
    - an ordering cost of $49 per order,
    - and an annual demand of 5000 units.
    EOQ MODEL WITH QUANTITY DISCOUNTS

    What order quantity should we select?

    The following three-step procedure shows the


    calculations necessary to make this decision.

    In the preliminary calculations, we use Q1 to


    indicate the order quantity for discount category 1,
    Q2 for discount category 2, and Q3 for discount
    category 3.
    EOQ MODEL WITH QUANTITY DISCOUNTS

    Step 1.
    For each discount category, compute a Q* using the
    EOQ formula based on the unit cost associated with
    the discount category.

    Recall that the EOQ model provides;

    where Ch = IC = (0.20)C. With three discount


    categories providing three different unit costs C, we
    obtain;
    EOQ MODEL WITH QUANTITY DISCOUNTS
    EOQ MODEL WITH QUANTITY DISCOUNTS

    Only differences in the EOQ values above come


    from slight differences in the holding cost, the
    economic order quantities resulting from this step
    will be close.

    However, these order quantities will usually not all


    be of the size necessary to qualify for the discount
    price assumed. In the preceding case, both Q*2 and
    Q*3 are insufficient order quantities to obtain their
    assumed discounted costs of $4.85 and $4.75,
    respectively.
    EOQ MODEL WITH QUANTITY DISCOUNTS

    For those order quantities for which the assumed


    price cannot be obtained, the following procedure
    must be used:

    Step 2.

    For the Q* that is too small to qualify for the


    assumed discount price, adjust the order quantity
    upward to the nearest order quantity that will allow
    the product to be purchased at the assumed price.
    EOQ MODEL WITH QUANTITY DISCOUNTS

    In our example, this adjustment causes us to set

    Q*2 = 1000 and Q*3 = 2500

    If a calculated Q* for a given discount price is large


    enough to qualify for a bigger discount, that value of
    Q* cannot lead to an optimal solution.

    Although the reason may not be obvious, it does


    turn out to be a property of the EOQ quantity
    discount model.
    EOQ MODEL WITH QUANTITY DISCOUNTS

    In the previous inventory models considered, the


    annual purchase cost of the item was not included
    because it was constant and never affected by the
    inventory order policy decision.

    However, in the quantity discount model, the annual


    purchase cost depends on the order quantity and
    the associated unit cost.

    Thus, annual purchase cost (annual demand D x


    unit cost C) is included in the equation for total cost,
    as shown here:
    EOQ MODEL WITH QUANTITY DISCOUNTS

    Using this total cost equation, we can determine the


    optimal order quantity for the EOQ discount model
    in step 3.
    EOQ MODEL WITH QUANTITY DISCOUNTS

    Step 3.

    For each order quantity resulting from steps 1 and


    2, compute the total annual cost using the unit price
    from the appropriate discount category and above
    equation

    The order quantity yielding the minimum total


    annual cost is the optimal order quantity.

    The step 3 calculations for the example problem are


    summarized in table below.
    EOQ MODEL WITH QUANTITY DISCOUNTS

    TOTAL ANNUAL COST CALCULATIONS FOR THE EOQ


    MODEL WITH QUANTITY DISCOUNTS
    EOQ MODEL WITH QUANTITY DISCOUNTS

    As we see, a decision to order 1000 units at the 3%


    discount rate yields the minimum cost solution.

    Even though the 2500-unit order quantity would


    result in a 5% discount, its excessive holding cost
    makes it the second-best solution.

    Figure below shows the total cost curve for each of


    the three discount categories. Note that Q* = 1000
    provides the minimum cost order quantity.

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