How do I calculate Economic Order Quantity (EOQ) and what does it actually mean?

Question

I'm preparing for CMA Inter Cost Accounting. I can apply the EOQ formula but I don't really understand why it works, and questions with discounts confuse me.

GradeHunt_Team · Answer

EOQ is the order size at which the total of ordering cost and carrying cost per year is the lowest.

Formula: EOQ = square root of (2 x A x O / C)
- A = annual demand in units
- O = cost of placing one order
- C = carrying cost per unit per year (often given as a % of unit price)

Why it works:
- Ordering cost falls as order size rises (fewer orders).
- Carrying cost rises as order size rises, because average stock is half the order size (Q/2).
- Total cost is lowest where the two are equal, and the formula finds that point.

Example:
A = 12,000 units, O = Rs 400 per order, unit price Rs 50, carrying cost 12% a year (C = Rs 6).
EOQ = square root of (2 x 12,000 x 400 / 6) = square root of 1,600,000 = 1,265 units (approx).
Orders a year = 12,000 / 1,265 = about 9.5.
Check: ordering cost = (12,000 / 1,265) x 400 = about Rs 3,794; carrying cost = (1,265 / 2) x 6 = about Rs 3,795. The two are equal at the EOQ, apart from rounding.

Questions with quantity discounts:
1. Find the EOQ.
2. Calculate total cost (purchase cost + ordering cost + carrying cost) at the EOQ.
3. Calculate total cost at each discount break above the EOQ. Use the discounted price for purchase cost, and also for carrying cost when carrying cost is given as a % of price. If it is given as a fixed rupee amount per unit, it stays the same.
4. Choose the quantity with the lowest total cost.

Exam tip: always show the total cost table for the discount options, even when one answer looks obvious. The table makes the comparison easy to follow, and the carrying cost at the discounted price is a common place to slip.

How do I calculate Economic Order Quantity (EOQ) and what does it actually mean?

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