In the above equation, D is the number of units XYZ requires per year, S is the fixed cost incurred each time an order is placed with XYZ’s manufacturer, Q is the fixed order quantity – each time an order is placed, exactly Q units are ordered, Q/2 is the average level of inventory held by ABC Company in a given inventory cycle, and C is the cost per unit associated with holding 1 unit of XYZ in inventory annually. Thus, S*(D/Q) is the annual cost of placing orders, while C*(Q/2) is the annual inventory holding cost. |