MSCI 432

Fall 2015

University of Waterloo
Faculty of Engineering
Department of Management Sciences

MSCI 432 Assignment 2 due Wednesday, October 14, 2015 (in class)
Problem 1
Consider an inventory with only four items with the following characteristics:
Item i
1
2
3
4

(units/year)
7200
4000
500
100

($/unit)
2.00
0.90
5.00
0.81

The inventory manager vehemently argues that there is no way that he can evaluate K and I (the
setup cost and the interest rate); however, he is prepared to admit that K/I is reasonably constant
across the items. He has been following an ordering policy of using a four-month time supply of
each item. He has been under pressure from the controller to reduce the average inventory level
by 25 percent. Therefore, he is about to adopt a three-month time supply.
a. Develop an EOQ aggregate exchange curve.
b. What are the values of TACS and N for K/I=200?
c. What K/I value gives the same TACS as the current rule?
d. What K/I value gives the same N as the proposed rule?
e. Use the curve to suggest an option or options open to the manager that is (are) preferable
to his proposed action.
Problem 2
Billys Bakery bakes fresh bagels each morning. The daily demand for bagels is a random variable
with a distribution estimated from prior experience given by
Number of bagels sold
in one day
0
5
10
15
20
25
30
35

Probability
0.05
0.10
0.10
0.20
0.25
0.15
0.10
0.05

The bagels cost Billys 8 cents to make, and they are sold for 35 cents each. Bagels unsold at the
end of the day are purchased by a nearby charity soup kitchen for 3 cents each.

MSCI 432

Fall 2015

a) Based on the given discrete distribution, how many bagels should Billys bake at the start
of each day? (Your answer should be a multiple of 5.)
b) If you were to approximate the discrete distribution with a normal distribution, would you
expect the resulting solution to be close to the answer that you obtained in part (a)? Why
or why not?
c) Determine the optimal number of bagels to bake each day using a normal approximation.
(Hint: You must compute the mean and the variance 2 of the demand from the given
discrete distribution.)
d) What is the profit or loss for your solution obtained from (a)?

Problem 3
The buyer for Needless Markup, a famous high end department store, must decide on the
quantity of a high-priced womans handbag to procure in Italy for the following Christmas season.
The unit cost of the handbag to the store is $28.50 and the handbag will sell for $150.00. Any
handbags not sold by the end of the season are purchased by a discount firm for $20.00. In addition,
the store accountants estimate that there is a cost of $0.40 for each dollar tied up in inventory, as
this dollar invested elsewhere could have yielded a gross profit. Assume that this cost is attached
to unsold bags only.
a) Suppose that the sales of the bags are equally likely to be anywhere from 50 to 250
handbags during the season. Based on this, how many bags should the buyer purchase?
(Hint: this means that the correct distribution of demand is uniform. You may solve this
problem assuming either a discrete or a continuous uniform distribution.)
b) A detailed analysis of past data shows that the number of bags sold is better described by
a normal distribution, with mean 150 and standard deviation 20. Now what is the optimal
number of bags to be purchased?

Problem 4
An automotive warehouse stocks a variety of parts that are sold at neighbourhood stores. One
particular part, a popular brand of oil filter, is purchased by the warehouse for $1.50 each. It is
estimated that the cost of order processing and receipt is $100 per order. The company uses an
inventory carrying charge based on a 28 percent annual interest rate.
The monthly demand for the filter follows a normal distribution with mean 280 and standard
deviation 77. Order lead time is assumed to be five months.
Assume that if a filter is demanded when the warehouse is out of stock, then the demand is backordered, and the cost assessed for each back-ordered demand is $12.80. Determine the following
quantities:
a) The optimal values of the order quantity and the reorder level.
b) The average annual cost of holding, setup, and stock-out associated with this item assuming
that an optimal policy is used.
c) Evaluate the cost of uncertainty for this process. That is, compare the average annual cost
you obtained in part (b) with the average annual cost that would be incurred if the lead time
demand had zero variance.
2

MSCI 432

Fall 2015

Problem 5
The home appliance department of a large department store is using a lot size-reorder point system
to control the replenishment of a particular model of FM table radio. The store sells an average of
10 radios each week. Weekly demand follows a normal distribution with variance 26.
The store pays $20 for each radio, which it sells for $75. Fixed costs of replenishment amount to
$28. The accounting department recommends a 20 percent interest rate for the cost of capital.
Storage costs amount to 3 percent and breakage to 2 percent of the value of each item.
If a customer demands the radio when it is out of stock, the customer will generally go elsewhere.
Loss-of-goodwill costs are estimated to be about $25 per radio. Replenishment lead time is three
months.
a) If lot sizes are based on the EOQ formula, what reorder level should be used for the radios?
b) Find the optimal values of (Q, R).
c) Compare the average annual costs of holding, ordering, and stock-out for the policies that
you found in parts (a) and (b).
d) Re-solve the problem using lost-sales version of the equation for R (see slide 22 of Lecture
6). What is the effect of including lost sales explicitly?
e) Re-solve for (Q, R) by replacing the stock-out cost with a 96 percent Type 1 service level.
f) Re-solve for (Q, R) by replacing the stock-out cost with a 96 percent Type 2 service level.
What is the imputed shortage cost?