3/15/2016

Practice Problem 8: Simsbury Steel Distributors | Week 5 Practice Problems | CTL.SC1x Courseware | edX

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Week 5:

Inventory
Management I
- Deterministic
Demand
Welcome to Week
5

PRACTICE PROBLEM 8: SIMSBURY STEEL DISTRIBUTORS

Simsbury Steel Distributors (SSD) have long been considered a power
house in the manufacturing and distribution of precision steel ball
bearings and other steel parts. It offers a wide range of products; from
highly engineered one of a kind fittings that they manufacture to standard
ball bearings and other more common parts that they source from other
suppliers. Their customers vary dramatically as well; from original
equipment manufacturers (OEMs) to construction companies.
You have been brought in to settle an internal feud. They want you to
come up with an inventory policy for a product, the Trojan1980, that SSD
sources from a smaller local vendor. The problem is that the finance and
planning groups do not agree with each other.
Please enter all your numerical answers with 4 significant figures.

Part 1
The finance team has conducted an analysis of the Trojan1980 and has
estimated that the ordering cost is $750 per order, annual demand is 900
units, and cost of holding inventory is 10% per year. The planning group,
on the other hand, estimates that the ordering cost is $1350 per order,
annual demand is 1600 units, and cost of holding inventory is 24% per
year. The two things they agree on are that demand is stable and that the
cost of the item is $1200 per unit.
You decide to see how big a difference these input factors make.
Using only the value estimates submitted by the finance and planning
groups, what is the LARGEST possible economic order quantity that you
would order? Round your answer to the nearest integer. (You can pick and
choose parameters from each group's estimate to make the largest EOQ.)

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Practice Problem 8: Simsbury Steel Distributors | Week 5 Practice Problems | CTL.SC1x Courseware | edX

Lesson 1:
Introduction to
Inventory
Management
Lesson 2:
Economic Order
Quantity
Lesson 3:
Extensions to the
EOQ Model
Economic Order
Quantity
Recitation

Answer: 190

EXPLANATION

The answer is 189.7 or 190 items per order. The first step is to select
which of the inputs would increase the size of the EOQ. Increased
demand, increased ordering costs, and decreased holding costs will all
lead to bigger EOQ. Therefore, we find EOQ where =1350 $/order,
D=1600 items/year, and =(1200)(0.10) = $120 $/year.
= 189.73 ~ 190 items/order

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Homework due Mar
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Part 2
Using only the value estimates submitted by the finance and planning
groups, what is the SMALLEST possible economic order quantity that you
would order? Round your answer to the nearest integer.

Answer: 68

EXPLANATION

The answer is 68.46 or 68 items per order. You need to select the
inputs that lead to the smallest possible EOQ. Decreased demand,
decreased ordering costs, and increased holding costs will all lead to
smaller EOQ. Therefore, we find EOQ where =750 $/order, D=900
items/year, and =(1200)(0.24) = $288 per year.
= 68.46 ~ 68 items/order. If you
rounded to 69, that is ok, but use 68 for the following problems.

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Practice Problem 8: Simsbury Steel Distributors | Week 5 Practice Problems | CTL.SC1x Courseware | edX

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Part 3
You now want to test the sensitivity of possible solutions. Using the largest
and smallest EOQ values you just calculated, what is the biggest percent
increase in total relevant costs that you would incur? In other words, what
is the worst case error if, for example, you used the smallest Q* value
when, in fact, the conditions were such that the largest Q* should have
been used. Or, vice versa. Enter in the percentage answer as a decimal
between 0 and 1 with three significant digits. For example, if your answer
is 23.87%, enter in 0.239.

Answer: 0.576

EXPLANATION

Using these estimated input values, the worst case is that we pick the
biggest Q* when the smallest Q* was optimal or just the opposite.
Notice that these two errors will be the same!
So, to find this percent error we just want to use the EOQ sensitivity
analysis equation with the values of
and
. The penalty
cost ratio is simply:

= 1.5760 ~ 57.6%
So, this means that the worst management cost penalty is 57% - even
with these extremely wide input estimates.

You have used 3 of 3 submissions

Part 4

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Practice Problem 8: Simsbury Steel Distributors | Week 5 Practice Problems | CTL.SC1x Courseware | edX

After finding the widest possible penalty-cost ratio you realize that this will
probably never happen since it assumes you select the biggest Q and the
conditions yielding the smallest Q are the true values. You decide to
estimate EOQ using the average, not the extreme, values of the inputs.
Let's call this
.
What is the maximum management-cost penalty if you order
? Enter
in the percentage answer as a decimal between 0 and 1 with two
significant digits. For example, if your answer is 23.87%, enter in 0.24.

Answer: 0.14

EXPLANATION

The answer is between 13.1% and 13.8% - we allowed anything

between 12.5 and 15.5%. Based on the estimates from the finance
and planning groups, we want to find EOQ where =(1350+750)/2=
1050 $/order, D=(1600+900)/2 = 1250 items/year, and =(1200)(0.10
+ 0.24)/2 = $204 $/year.
Using these values gives us

= 113.43

~ 113 items/order.
Now we want to plug this into the EOQ sensitivity equation using

= 1.131
~ 13%
= 1.138 ~
14%
So, this means that by selecting the middle ground in estimating the
EOQ your worst possible cost penalty is about 13%! That is amazing.
This shows how robust the EOQ model can be in estimating order
size.
This problem is based on an example by L.B. Schwarz (2008),
"Economic Order Quantity Model," Building Intuition: Insights from
Basic Operations Management Models and Principles.

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Practice Problem 8: Simsbury Steel Distributors | Week 5 Practice Problems | CTL.SC1x Courseware | edX

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