A purchase manager has decided to place an order for a minimum quantity of 500 numbers of a particular item in order to get a discount of 10%. From the past records, it was found out that in the last year, 8 orders, each of size 200 units, were placed. Given the ordering cost – Rs. 500 per order, inventory carrying cost is 40% of the inventory value and the price of the item is Rs. 400 per unit. Is the purchase manager justified in his decision? What is the effect of his decision to the company? -

$\text{Demand} \hspace{3.1cm} D = 200×8 = 1600 \ \text{units/year} \\ \text{Unit cost} \hspace{3cm} Cp = Rs. 400 \ \text{per unit} \\ \text{Discounted unit cost} \hspace{1cm} Cp’ = Rs. 360 per unit (10 \% discount) \\ \text{Inventory holding costs} \hspace{0.6cm} Ch = 40 \% of Cp \\ \text{Cost of each order} \hspace{1.6cm} Co = Rs. 500$

In the previous year:

Order quantity Q = 200 units; unit cost = Rs. 400

$\text{Total cost}$ $= \text{average inventory cost + ordering cost + cost of units} \\ = Q.Ch2 + D.CoQ + D×Cp \\ = 200×400×0.42 + 8×500 + 1600×400 \\ = Rs. 660000$

In the current year:

Order quantity Q = 500 units; discounted unit cost = Rs. 360

$\text{Total cost}$ $= \text{average inventory cost + ordering cost + cost of units} \\ = Q.Ch2 + D.CoQ + D×Cp \\ = 500×360×0.42 + 1600×500500 + 1600×360 \\ = Rs. 613600$

So the manager is justified in his decision to place an order of 500 units, and avail of the discount of 10% in cost price of the item.