WorkedExamplesforChapter18

ExampleforSection18.3
Computronicsisamanufacturerofcalculators,currentlyproducing200perweek.One
componentforeverycalculatorisaliquidcrystaldisplay(LCD),whichthecompany
purchasesfromDisplays,Inc.(DI)for$1perLCD.Computronicsmanagementwantsto
avoidanyshortageofLCDs,sincethiswoulddisruptproduction,soDIguaranteesa
deliverytimeof1/2weekoneachorder.Theplacementofeachorderisestimatedto
require1hourofclericaltime,withadirectcostof$15perhourplusoverheadcostsof
another$5perhour.Aroughestimatehasbeenmadethattheannualcostofcapitaltied
upinComputronicsinventoryis15percentofthevalue(measuredbypurchasecost)of
theinventory.OthercostsassociatedwithstoringandprotectingtheLCDsininventory
amountto5centsperLCDperyear.

(a)WhatshouldtheorderquantityandreorderpointbefortheLCDs?Whatisthe
correspondingtotalvariableinventorycostperyear(holdingcostsplus
administrativecostsforplacingorders)?

WecalculatethedataneededforthebasicEOQmodelasfollows:

DemandperyearforLCD=52(200/week)=10,400/year.

Setupcost=directcost+overheadcost=($15/hr)(1hr)+($5/hr)(1hr)
=$15+$5=$20.

Unitholdingcost=15%ofthevalueofeachLCD+5centsofstoringand
protectingcostperLCD
=15%($1)+$0.05=$0.20perLCD.

Deliverytime=1/2week=3.5days.

Workingdaysperyear=365days/year.

WeusetheExceltemplateforthebasicEOQModel(shownnext)andobtainthe
followingsolutions:

Optimalorderquantity=1442.

Reorderpoint=99.7.

Totalvariableinventorycostperyear=$288.44.
(b)SupposethetrueannualcostofcapitaltiedupinComputronicsinventory
actuallyis10percentofthevalueoftheinventory.Thenwhatshouldtheorder
quantitybe?Whatisthedifferencebetweenthisorderquantityandtheone
obtainedinpart(a)?Whatwouldthetotalvariableinventorycostperyear(TVC)
be?HowmuchmorewouldTVCbeiftheorderquantityobtainedinpart(a)still
wereusedherebecauseoftheincorrectestimateofthecostofcapitaltiedupin
inventory?

Ifthetrueannualcosttiedupininventoryis10%ofthevalueoftheinventory,theunit
holdingcostbecomes:

Unitholdingcost =10%ofthevalueofeachLCD+5centsofstoringand
protectingcostperLCD
=10%($1)+$0.05=$0.15perLCD.

Theneworderquantityis1665,anincreaseof223(=16651442)LCDsfromtheorder
quantityinpart(a).

Thetotalvariableinventorycostperyearis$249.80.

Iftheorderquantityinpart(a)wereused,thetotalvariableinventorycostperyearis

20(10,400/1442)+0.15(1442/2)=$252.39,

anincreaseof$2.59from$249.80.
(c)Repeatpart(b)ifthetrueannualcostofcapitaltiedupinComputronics
inventoryactuallyis20percentofthevalueoftheinventory.

Ifthetrueannualcosttiedupininventoryis20%ofthevalueoftheinventory,theunit
holdingcostbecomes:

Unitholdingcost =20%ofthevalueofeachLCD+5centsofstoringand
protectingcostperLCD
=20%($1)+$0.05=$0.25perLCD.

Theneworderquantityis1290,adecreaseof152(=12901442)LCDsfromtheorder
quantityinpart(a).

Thetotalvariableinventorycostperyearis$322.49.

Iftheorderquantityinpart(a)wereused,thetotalvariableinventorycostperyearis

20(10,400/1442)+0.25(1442/2)=$324.50,

anincreaseof$2.01from$322.49.
(d)Performsensitivityanalysissystematicallyontheunitholdingcostbygenerating
atablethatshowswhattheoptimalorderquantitywouldbeifthetrueannualcost
ofcapitaltiedupinComputronicsinventorywereeachofthefollowingpercentages
ofthevalueoftheinventory:10,12,14,16,18,20.

Foreachofthesepercentagesfortheannualcostofcapitaltiedupininventory,we
calculatetheunitholdingcostandusetheExceltemplateforthebasicEOQmodelto
obtainthecorrespondingorderquantity,asgiveninthefollowingtable.

Costofcapital Unitholdingcost Orderquantity

(LCDs)
10% $0.15 1665
12% $0.17 1564
14% $0.19 1480
16% $0.21 1407
18% $0.23 1345
20% $0.25 1290

(e)Assumingthattheroughestimateof15percentiscorrectforthecostofcapital,
performsensitivityanalysisonthesetupcostbygeneratingatablethatshowswhat
theoptimalorderquantitywouldbeifthetruenumberofhoursofclericaltime
requiredtoplaceeachorderwereeachofthefollowing:0.5,0.75,1,1.25,1.5.

Foreachofthesehoursofclericaltimerequiredtoplaceanorder,wecalculatethesetup
costandusetheExceltemplateforthebasicEOQmodeltoobtainthecorresponding
orderquantity,asgiveninthefollowingtable.

ClericalTime(hrs) SetupCost Orderquantity

(LCDs)
0.5 $10 1020
0.75 $15 1249
1 $20 1442
1.25 $25 1612
1.5 $30 1776

(f)Performsensitivityanalysissimultaneouslyontheunitholdingcostandthesetup
costbygeneratingatablethatshowstheoptimalorderquantityforthevarious
combinationsofvaluesconsideredinparts(d)and(e).
Theorderquantitiesforvariouscombinationsofthecostofcapital(unitholdingcost)
andclericaltime(setupcost)aregivennext.

UnitHolding Setupcost
Cost $10 $15 $20 $25 $30
$0.15 1178 1442 1665 1862 2040
$0.17 1106 1355 1564 1749 1916
$0.19 1046 1281 1480 1654 1812
$0.21 995 1219 1407 1574 1724
$0.23 951 1165 1345 1504 1647
$0.25 912 1117 1290 1442 1580

ExampleforSection18.4
Considerasituationwhereaparticularproductisproducedandplacedinin
processinventoryuntilitisneededinasubsequentproductionprocess.Nounits
currentlyareininventory,butthreeunitswillbeneededinthecomingmonthand
anadditionalfourunitswillbeneededinthefollowingmonth.Theunitproduction
costisthesameineithermonth.Thesetupcosttoproduceineithermonthis$5,000.
Theholdingcostforeachunitleftininventoryattheendofamonthis$1,000.
Determinetheoptimalschedulethatsatisfiesthemonthlyrequirementsby
usingthealgorithmpresentedinSec.18.4.

UsingthenotationofSec.18.4,thedemandsforthetwomonthsare

r1=3, r2=4,

andthecostparametersforthemodelinSec.18.4(inunitsofthousandsofdollars)are

K=5, h=1.

Therefore,thetotalvariablecost(whichexcludestheunitproductioncost)ofanoptimal
policyformonth2whenthatmonthstartswithzeroinventory(beforeproducing)is

C2=C3+K=0+5=5.

Thevariablecostofthepolicyassociatedwithproducingonlywhatisneededfor
month1andthenproducingonlywhatisneededformonth2is

C (1)
1 =C2+K=5+5=10.
Thevariablecostofthepolicyassociatedwithproducingenoughinmonth1tomeetthe
demandforbothmonthsis

C (2)
1 =C3+K+hr2=0+5+1(4)=9.

Theminimumofthevariablecostsofthesetwopoliciesis

C1=min{ C (1) (2)

1 , C 1 }=min{10,9}=9,

sotheoptimalpolicyistoproduceall7unitsinmonth1thatareneededforbothmonths
1and2.

ExampleforSection18.6
MicroAppleisamanufacturerofpersonalcomputers.Itcurrentlymanufacturesasingle
modeltheMacinDOSonanassemblylineatasteadyrateof500perweek.
MicroAppleordersthefloppydiskdrivesfortheMacinDOS(1percomputer)froman
outsidesupplieratacostof$30each.Additionaladministrativecostsforplacinganorder
total$30.Theannualholdingcostis$6perdrive.IfMicroApplestocksoutoffloppy
diskdrives,productionishalted,costing$100perdriveshort.Becauseoftheseriousness
ofstockouts,managementwantstokeepenoughsafetystocktopreventashortagebefore
thedeliveryarrivesduring99percentoftheordercycles.
Thesuppliernowisofferingtwoshippingoptions.Withoption1,theleadtime
wouldhaveanormaldistributionwithameanof0.5perweekandastandarddeviationof
0.1perweek.Foreachorder,theshippingcostchargedtoMicroApplewouldbe$100
plus$3perdrive.Withoption2,theleadtimewouldhaveauniformdistributionfrom
1.0weeksto2.0weeks.Foreachorder,theshippingcostchargedtoMicroApplewould
be$20plus$2perdrive.

(a)UsethestochasticcontinuousreviewmodelpresentedinSec.18.6toobtainan
(R,Q)policyundereachofthesetwoshippingoptions.

Fromtheproblemdescription,thedataforthecontinuousreviewmodelarethe
following:

Unittime=1year.
Demand,d=(500/week)(52weeks/year)=26,000floppydiskdriversperyear.
Annualholdingcostperdiskdriver,h=$6.
Shortagecostperdiskdrive,p=$100.
Servicelevel,L=99%.

Foroption1:
Setupcostforplacingandshippinganorder,K=$30+$100=$130.
Theleadtimehasanormaldistribution.
Theaveragedemandduringtheleadtimeis(500/week)(1/2week)=250.
Thestandarddeviationofdemandduringtheleadtimeis(500/week)(0.1week)=50.

UsingtheExceltemplateforthestochasticcontinuousreviewmodel,asshown
next,weobtaintheorderquantityQ=1093andreorderpointR=366.

Foroption2:

Setupcostforplacingandshippinganorder,K=$30+$20=$50.
Theleadtimehasauniformdistribution.
Thelowerendpointa=(500/week)(1week)=500.
Theupperendpointb=(500/perweek)(2weeks)=1000.

UsingtheExceltemplateforthestochasticcontinuousreviewmodel,asshown
next,weobtaintheorderquantityQ=678andreorderpointR=995.
(b)Showhowthereorderpointiscalculatedforeachofthesetwopolicies.

Thereorderpointofoption1is

R=+KL=250+2.327(50)=366.

Thereorderpointofoption2is

R=a+L(ba)=500+0.99(1000500)=995.

(c)Determineandcomparetheamountofsafetystockprovidedbythesetwo
policies.

Thesafetystockofoption1=Rmean=366250=116.

Thesafetystockofoption2=Rmean=995750=245.

(d)Determineandcomparetheaverageannualholdingcostunderthesetwo
policies.

116
Theaverageannualholdingcostofoption1=($6) =$3975.

245
Theaverageannualholdingcostofoption2=($6) =$3504.

(e)Determineandcomparetheaverageannualacquisitioncost(combiningshipping
costandpurchaseprice)underthesetwopolicies.

Foroption1:

Theannualshippingcost=K(d/Q)+($3)d =($130)(26,000/1093)+($3)(26,000)
=$81,092.

Theannualpurchasecost=($30)(26,000)=$780,000.

Hence,theannualacquisitioncost=$81,092+$780,000=$861,092.

Foroption2:

Theannualshippingcost=K(d/Q)+($2)d =($50)(26,000)/678)+($2)(26,000)
=$53,917.
Theannualpurchasecost=($30)(26,000)=$780,000.

Hence,theannualacquisitioncost=$53,917+$780,000=$833,917.

(f)Sinceshortagesareveryinfrequent(andverysmallwhentheydooccur),the
onlyimportantcostsforcomparingthetwoshippingoptionsarethoseobtainedin
parts(d)and(e).Addthesecostsforeachoption.Whichoptionshouldbeselected?

Foroption1:$3,975+$861,092=$865,067.

Foroption2:$3,504+$833,917=$837,421.

Weshouldselectoption2.

ExampleforSection18.7
ThemanagementofQualityAirlineshasdecidedtobaseitsoverbookingpolicyonthe
stochasticsingleperiodmodelforperishableproducts,sincethiswillmaximizeexpected
profit.ThispolicynowneedstobeappliedtoanewflightfromSeattletoAtlanta.The
airplanehas125seatsavailableforafareof$250.However,sincetherecommonlyarea
fewnoshows,theairlineshouldacceptafewmorethan125reservations.Onthose
occasionswhenmorethan125peoplearrivetotaketheflight,theairlinewillfind
volunteerswhoarewillingtobeputonalaterflightinreturnforbeinggivenacertificate
worth$150towardanyfuturetravelonthisairline.
Basedonpreviousexperiencewithsimilarflights,itisestimatedthattherelative
frequencyofthenumberofnoshowswillbeasshownbelow.

NumberofNoShows RelativeFrequency
0 5%
1 10%
2 15%
3 15%
4 15%
5 15%
6 10%
7 10%
8 5%

(a)Wheninterpretingthisproblemasaninventoryproblem,whataretheunitsofa
perishableproductbeingplacedintoinventory?
Wheninterpretingthisproblemasaninventoryproblem,overbookedreservationsare
perishableproductsthatarebeingplacedintoinventory.

(b)Identifytheunitcostofunderorderingandtheunitcostofoverordering.

Cunder=lostfare=$250.

Cover=costofcertificate=$150.

(c)Usethestochasticsingleperiodmodelforperishableproductswiththesecoststo
determinehowmanyoverbookedreservationstoaccept.

Servicelevelforaccepting0=0.05
Servicelevelforaccepting1=0.05+0.1=0.15.
Servicelevelforaccepting2=0.15+0.15=0.3.
Servicelevelforaccepting3=0.3+0.15=0.45.
Servicelevelforaccepting4=0.45+0.15=0.6.
Servicelevelforaccepting5=0.6+0.15=0.75.
Servicelevelforaccepting6=0.75+0.1=0.85.
Servicelevelforaccepting7=0.85+0.1=0.95.
Servicelevelforaccepting8=0.95+0.05=1.

Cunder 250
Optimalservicelevel= C = =0.625.
under 250

Theresultsforthismodelwhenthedemandisanintegervaluedrandomvariable
indicatethatthesmallestintegerorderquantitywhoseservicelevelisthisoptimal
servicelevelshouldbeused.Therefore,QualityAirlinesshouldaccept5overbooked
reservations.

(d)DrawagraphoftheCDFofdemandtoshowtheapplicationofthemodel
graphically.