Decision Making Models

Posted: September 9th, 2013

Decision Making Models

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Decision Making Models

For firms to arrive at making constructive decisions for the company there are several techniques that it has to adapt. These techniques enable the firm to make informed decisions regarding the number of production units it can purchase or employ to produce more commodities or the factors to be applied in the effective management of company inventory. Quantitative techniques such as Economic Order Quantity (EOQ) model and the Economic production lot size model are used to aid in making decisions in ordering, holding and production of raw materials for finished products.

A.        The EOQ Model is a classical model used to manage the inventory of a company by minimizing the costs of ordering and holding inventory. The model pertains when demand for a product is constant throughout the year and each new order is delivered in full when inventory is null. The order cost is assumed a constant, the demand rate is acknowledged with certainty, the lead-time for the receipt of orders is invariable, there are no shortages or stock outs, no discounts in order quantities, purchase price is steady, replenishment of materials also takes place immediately, and only one product is involved. The formula for the EOQ model is:

EOQ = √ (2×D×S)/H, where, D= Annual demand (units), S= Cost per order ($), C= Cost per unit ($), I= Holding cost (%) and H= Holding cost ($) = I ×C

For instance, a company A has a uniform demand throughout the year and totals 18000 units per year. Its ordering costs total $38 per order. The annual holding cost rate is 26% of the value of the inventory. The cost per unit of inventory is $12. The order size or quantity for company A would be:

EOQ = √ (2×18000×$38)/ (26%×$12) = 662.164 units

Therefore, company A will order 662 units to cater for the constant demand over the year as well as the efficient production of goods.

B.        The Economic production lot size model is a variation of the EOQ model. This model determines the optimum quantity for production. It assumes that the all the orders received immediately are relaxed. The order quantity is also assumed to be gradually received over time, and the level of inventory is exhausted at the same time it is being produced. The model is most frequently used whereby the consumer of the inventory is also the producer. A similar predicament can also occur whereby the orders are received gradually overtime or if the manufacturer is also the retailer. The formula for the economic production lot size model is:

EOQ= √ (2×D×S)/ H (1- d/p), where d = daily demand rate, p = production rate

For instance, a company B has a uniform demand throughout the year of 15000 units per year. The set ups for the production cost $84 per set up. The annual holding cost rate is 28% of the value of inventory. The cost per unit of the finished product is $19. The production rate is constant and is equivalent to 60000 units per year. The lot size for the company would be:

EOQ= √ (2×15000×$84)/ (28%×$19) × (1- {15000/365}/60000) = 688.011 units

Therefore, company B will have a production quantity of 688 units due to the constant demand overtime as well as the constant production rate.

It is necessary for a firm to manage its inventory. Quality management of the company inventory enables the firm to plan for the time and the units it has to employ in the production of goods and keep a record of the finished products to avoid wastage of production units due to poor records of inventory levels. With efficient inventory management, a firm makes profitable decisions and choice for the company.