Question

Suppose that a company needs 1, 200,000 items during a year and that preparation for each production run costs $500. Suppose also that it costs $29 to produce each item and $3 per year to store an item. Use the inventory cost model to find the number of items in each production run so that the total costs of production and storage are minimized. _ times items/run

Answer 1

Answer:

The number of items in each production run so that the total costs of production and storage are minimized is 8165 items/run

Step-by-step explanation:

We will use the following variables:

Q = Quantity being ordered

Q* = the optimal order Quantity: the result being sought

D = annual Demand for the item, over the year

P = unit Production cost

S = cost of setting up a production run, regardless of the number of units in the production run (fixed cost per production run)

H = annual cost to Hold one unit

It is important to note which variables are annualized, which are per-order and which are per-unit.

Using the variables, here are the components of the first equation

Total Cost, TC = PC + SC + HC

PC = P x D :  Production Cost = unit Production cost times the annual Demand

SC = (D x S)/Q : Setting up Cost = annual Demand times cost per production setup, divided by the order Quantity (number of units)

HC = (H x Q)/2: Holding Cost = annual unit Holding cost times order Quantity (number of units), divided by 2 (because throughout the year, on average the warehouse is half full).

So TC = PC + SC + HC =  (P x D) + ((D x S)/Q) + ((H x Q)/2) = PD + (DS/Q) + HQ/2

To obtain the optimal order quantity, Q* that minimizes TC, at the minimum TC, dTC/dQ = 0

dTC/dQ = (H/2) – (D x S)/(Q²) = 0

(H/2) – (D x S)/(Q²) = 0

Solving for Q, which is Q* at this point.

(Q*)² = 2DS/H

Q* = √(2DS/H)

D = annual demand for the item = 200000

S = cost of setting up a production run, regardless of the number of units in the production run (fixed cost per production run) = $500

H = annual cost to Hold one unit = $3

Q* = √(2×200000×500/3) = 8164.97 = 8165 items.