A company uses 20,000 units of a material each year. The purchase price is $20 per unit, ordering costs are $50 per order, and holding costs are 10% of the purchase price per unit per year. If the company orders the EOQ, what is the total annual ordering and holding cost?

Correct answer: A) $2,000

Explanation

Holding cost per unit = 10% x $20 = $2. EOQ = square root of (2 x 50 x 20,000 / 2) = square root of 1,000,000 = 1,000 units. Ordering cost = (20,000 / 1,000) x 50 = $1,000. Holding cost = (1,000 / 2) x 2 = $1,000, based on average inventory. Total = $2,000; at the EOQ, ordering and holding costs are always equal. Including the purchase cost of $400,000 would give $402,000.