ABSTRACTThe formulation of the classic economic production quantity (EPQ) model is extended to include setup cost as a function of capital expense. Additional capital will buy reduced setup cost. Thus, the objective now is to balance holding, setup, and capital expenses.This new formulation is solved under conditions where setup cost varies exponentially and linearly as a function of capital expense. Decision rules are formulated to indicate under what conditions setup cost reduction reduces total cost. For the linear function, it is shown that once the decision to reduce setup cost is justified, the optimal choice is the minimum setup cost that is technologically feasible.