Carrying costs of inventory
These are costs incurred because the firm has decided to maintain inventories. They generally consist of:
• Stock-out costs• Insurance costs• Warehouse and storage costs• Material handling costs• costs of obsolescence Total Ordering Cost = (Total demand for period x Ordering Costs per period) / Quantity Ordering = DO/QTotal Holding Costs = (Quantity Ordered x Holding Costs per unit) / 2 = Q H/2Therefore total relevant costs (TC) for any order quantity can be expressed as:
TC = DO/Q + Q H/2 We can determine a minimum of this total cost function by:
i. Differentiating the above formula with respect to Q and setting the derivative (1st) equal to zero.
dTC/ dQ = (-DO/Q2) + H/2 = 0
ii. Equating ordering costs to holding costs.
DO/Q = Q H/2