Consider a hardware supply warehouse that is contractually obligated to deliver 1,000 units of specialized fastener to a local manufacturing company each week. Each time the warehouse places an order for these items from its supplier, an ordering and transportation fee of $20 is charged to the warehouse. The warehouse pays $1.00 for each fastener and charges the local firm $5.00 for each fastener. Annual holding costs is 25 percent of inventory value, or $0.25 per year. The warehouse manager would like to know how much to order when inventory gets to zero. To answer this question, we can use the formula defined above. Annual demand (assuming the manufacturing plant operations for 50 weeks a year ) is 50,000 units, annual holding cost is $0.25 per unit, and fixed setup cost per unit is $20.00. Each time the warehouse places an order, the optimal order quantity is thus 2,828.
Instructor requirements: Apply the economic order quantity formula to the data in Example above, and reproduce the answer of 2,828 units. Also, calculate the total annual cost incurred for the economic order quantity.
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