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13-1
Chapter 12 - Inventory Management
(3) Demand is spread evenly throughout the year so that the demand rate is reasonably
constant.
(4) Lead time is known and constant.
(5) Each order is received in a single delivery.
(6) There are no quantity discounts.
b. Despite issues with values in the EOQ formula being at best educated guesses, the total cost
curve is relatively flat near the EOQ, so that there is a “zone” of values of order
quantity for which the total cost is close to its minimum. The fact that the EOQ calculation
involves taking a square root lessens the impact of estimation errors. Also, errors may cancel
each other out.
8. As the carrying cost increases, holding inventory becomes more expensive. Therefore, to avoid
higher inventory carrying costs, the company will order more frequently in smaller quantities
because ordering smaller quantities will lead to carrying less inventory.
9. Safety stock is inventory held in excess of expected demand to reduce the risk of stockout
presented by variability in either lead time or demand rates.
10. a. Safety stock would be large when large variations in lead time and/or usage are present.
b. Safety stock would be small when small variations in lead time and/or usage are present.
c. Safety stock would be zero when lead time and usage are constant, or when the service level
is 50 percent (and hence, z = 0).
11. Service level can be defined in a number of ways. The text focuses mainly on “the probability
that demand will not exceed supply during lead time, i.e., that the amount of stock on hand will
be sufficient to meet demand.” Other definitions relate to the percentage of cycles per year
without a stockout, or the percentage of annual demand satisfied from inventory.
Increasing the service level requires increasing the amount of safety stock.
12. The A-B-C approach refers to the classification of inventory items according to some measure of
importance, usually annual dollar value, and allocating control efforts on that basis. Although
annual dollar value may be the primary factor, a manager could consider other factors when
making exceptions, e.g., the risk of obsolescence, the risk of a stockout, the distance of a supplier,
etc.
13. In effect, this situation is a “quantity discount” case with a time dimension. Hence, buying larger
quantities will result in lower annual purchase costs, lower ordering costs (due to fewer orders),
but increased carrying costs. Because it is unlikely that the compressor supplier announces price
increases far in advance, the purchasing agent will have to develop a forecast of future price
increases to use in determining order size. Unlike the standard discount approach, the agent may
opt to use trial and error to determine the best order size, taking into account the three costs
(carrying, ordering and purchasing). In any event, it is reasonable to expect that a larger order size
would be more appropriate; although obsolescence also may be a factor.
14. A decrease in setup time will cause a decrease in the numerator of the formula for the economic
run quantity (Economic Production Quantity). This will lead to a decrease in the economic run
quantity. When the economic run quantity (Qp) decreases, the maximum inventory (Imax) and the
average inventory (Imax / 2) will decrease. This decrease in average inventory would be beneficial
because Annual Carrying (Holding) Cost would decrease.
15. The single-period model is used to handle ordering of perishables (e.g., fresh fruits, vegetables,
seafood, & cut flowers) and items that have a limited useful life (e.g., newspapers, magazines, &
spare parts for specialized equipment) and when items are not carried over from one period to the
next. It is appropriate to use this model when the previous conditions are met and when shortage
and excess costs can be estimated accurately.
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Chapter 12 - Inventory Management
16. The optimal stocking level can be less than the expected demand when excess costs are high and
shortage costs are low.
17. A company can reduce the need for inventories by:
a. using standardized parts for multiple products
b. improving demand forecasting
c. using preventive maintenance on equipment and machines
d. reducing supplier delivery lead times and increasing delivery reliability
e. improving the relationships and information sharing in the supply chain
f. restructuring the supply chain so that the supplier holds the inventory
g. reducing production lead time by using more efficient manufacturing methods
h. developing simpler product designs with fewer parts.
Taking Stock
1. a. If we buy additional amounts of a particular good to take advantage of quantity discounts,
then we will save money on purchasing cost per unit and annual purchasing costs of the item.
We also will save on ordering cost because we will place fewer orders per year. However, as
a result of ordering larger quantities with fewer orders, we will have to carry larger inventory
in stock, which in turn will result in an increase in inventory holding cost.
b. If we treat holding cost as a percentage of the unit price, then as the unit price increases, so
will the holding cost. As a result, if we are using the EOQ approach, we will place smaller
orders, resulting in reduced average inventory. On the other hand, if we use a constant
amount of a holding cost, the inventory decisions will not be affected by the changes in unit
cost (price) of the item.
c. Conducting a cycle count once a quarter instead of once a year will result in more frequent
counting, which will result in an increase in labor and overhead costs. However, the more
frequent counting also would lead to fewer errors in inventory accuracy and more timely
detection of errors, which in turn would lead to timely deliveries to customers, less work in
process inventory, more efficient operations, improved customer service, and greater
assurance of material availability.
2. When making inventory decisions involving holding costs, setting inventory levels, and deciding
on quantity discount purchases, the materials manager, the plant manager, the production
planning and control manager, the purchasing manager, and in some cases, the planners who
work in production planning and control and the buyers should be involved. Accounting and/or
finance might be needed for limited assistance in estimating costs. The level and the nature of
involvement of all parties will depend on the organizational structure of the company and the type
of product being manufactured or purchased.
3. Technology has had a tremendous impact on inventory management. The utilization of bar coding
and RFID tags has reduced the cost of taking physical inventory and has enabled real time
updating of inventory records. The satellite control systems that are available in trucks and
automobiles have enabled companies to determine and track the location of in-transit inventory.
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Chapter 12 - Inventory Management
and increased need for coordinating shipments from suppliers so that transportation cost and
performance are optimized. Increasing the variety of items on the menu will also cause problems
with forecasting. Because there will be more items on the menu, it is likely that the demand for
current menu items will decrease. Forecasts for all items will need to be revised. If we are not
able to estimate this possible decrease, then the forecasting problem will result in excess or
insufficient inventory levels.
2. A supermarket manager could evaluate criticalness of an inventory shortage by answering the
following questions:
a. How important is the item? For example, does it relate to a holiday or other important events,
e.g., a graduation?
b. Are comparable substitutes readily available within the manager’s supermarket?
c. What alternatives are available at other supermarkets?
d. Is this an occasional occurrence, or indicative of a larger, perhaps ongoing, problem?
4. Student answers will vary. Some possible answers are provided below:
a. Intentionally over-estimating or under-estimating any inventory costs would violate the
Virtue Principle.
b. If a buyer purchased two years’ worth of an item to decrease purchasing costs, this action
would violate the Utilitarian Principle due to the increase in carrying costs.
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Chapter 12 - Inventory Management
Solutions
1. a. Given:
Annual
Unit Volume
Item Cost (00)
1 $100 25
2 $80 30
3 $15 60
4 $50 10
5 $11 70
6 $60 85
Step 1:
Determine the Annual Dollar Value (Unit Cost * Annual Volume) for each item and the sum of
the individual Annual Dollar Values.
Annual Annual
Unit Volume Dollar
Item Cost (00) Value
1 $100 25
$2,500
2 80 30
2,400
3 15 60
900
4 50 10
500
5 11 70
770
6 60 85
5,100
12,170
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Chapter 12 - Inventory Management
Step 2:
Arrange the items in descending order based on Annual Dollar Values. Determine the A, B, and
C items. Then, determine the percentage of items and the percentage of Annual Dollar Value for
each category (round to two decimals).
Annual
Dollar Percentage of Percentage of Annual
Item Value Category Items Dollar Value
16.67% 41.91%
6 $5,100 A
[(1/6)*100] [($5,100/$12,170)*100]
2 [(2/6)*100] [($4,900/$12,170)*100]
2,400 B
3 900
50.00% 17.83%
5 770 C
[(3/6)*100] [($2,170/$12,170)*100]
4 500
b. Given:
D = 4,500, S = $36, and H = $10.
c. Given:
D = 18,000/year, S = $100, H = $40 per unit per year, p = 120 units per day, and u = 90
units/day.
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Chapter 12 - Inventory Management
2. a. Given:
The following table contains figures on the monthly volume and unit costs for a random
sample of 16 items. Develop an A-B-C classification for these items:
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Chapter 12 - Inventory Management
Step 1:
Determine the Annual Dollar Value (Unit Cost * Usage) for each item and the sum of the
individual Annual Dollar Values.
Annual
Dollar
Item Unit Cost Usage Value
K34 $10 200 $2,000
K35 25 600 15,000
K36 36 150 5,400
M10 16 25 400
M20 20 80 1,600
Z45 80 200 16,000
F14 20 300 6,000
F95 30 800 24,000
F99 20 60 1,200
D45 10 550 5,500
D48 12 90 1,080
D52 15 110 1,650
D57 40 120 4,800
N08 30 40 1,200
P05 16 500 8,000
P09 10 30 300
94,130
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Chapter 12 - Inventory Management
Step 2:
Arrange the items in descending order based on Annual Dollar Values. Determine the A, B,
and C items. Then, determine the percentage of items and the percentage of Annual Dollar
Value for each category (round to two decimals).
Annual
Dollar Percentage of Percentage of Annual
Item Value Category Items Dollar Value
F95 $24,000
18.75% 54.83%
Z45 16,000 A
[(3/16)*100] [($55,000/$94,130)*100]
K35 15,000
P05 8,000
F14 6,000
31.25% 31.55%
D45 5,500 B
[(5/16)*100] [($29,700/$94,130)*100]
K36 5,400
D57 4,800
K34 2,000
D52 1,650
M20 1,600
F99 1,200 50.00% 10.02%
C
N08 1,200 [(8/16)*100] [($9,430/$94,130)*100]
D48 1,080
M10 400
P09 300
94,130 100.00% 100.00%
b. Given:
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Chapter 12 - Inventory Management
Step 1:
Determine the Annual Dollar Value (Usage * Unit Cost) for each item and the sum of the
individual Annual Dollar Values.
Annual Dollar
Item Usage Unit Cost Value
4021 90 $1,400 $126,000
9402 300 12 3,600
4066 30 700 21,000
6500 150 20 3,000
9280 10 1,020 10,200
4050 80 140 11,200
6850 2,000 10 20,000
3010 400 20 8,000
4400 5,000 5 25,000
228,000
Step 2:
Arrange the items in descending order based on Annual Dollar Values. Determine the A, B,
and C items. Then, determine the percentage of items and the percentage of Annual Dollar
Value for each category (round to two decimals).
Percentage of Annual
Annual Percentage Dollar Value
Item Dollar Value Category of Items
11.11% 55.26%
4021 $126,000 A [(1/9)*100] [$126,000/$228,000)*100]
4400 25,000
33.33% 28.95%
4066 21,000 B [(3/9)*100] [$66,000/$228,000)*100]
6850 20,000
4050 11,200
9280 10,200
55.56% 15.79%
3010 8,000 C [(5/9)*100] [$36,000/$228,000)*100]
9402 3,600
6500 3,000
228,000 100.00% 100.00%
c. Determine the percentage of items in each category and the annual dollar value for each
category.
Reference table above.
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Chapter 12 - Inventory Management
3. Given:
D = 1,215 bags per year
S = $10
H = $75
Note: Round the EOQ to an integer value, but round any other values to a maximum of two
decimals.
a. Determine the EOQ:
2DS 2(1,215)10
Q0 18 bags
H 75
b. Determine the average inventory:
𝑄 𝐷 18 1,215
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 = ( ) 75 + ( ) 10 = $675 + $675 = $1,350
2 𝑄 2 18
e. Assuming that holding cost per bag increases by $9/bag/year, what would happen to total
cost?
New H = $75 + $ 9 = $84.
2(1,215)(10)
Q0 17 bags
84
𝑄 𝐷 17 1,215
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 = ( ) 84 + ( ) 10 = $714 + $714.71 = $1,428.71
2 𝑄 2 17
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Chapter 12 - Inventory Management
4. Given:
D = 40/day x 260 days/yr. = 10,400 boxes
S = $60. H = $30.
Note: Round the EOQ to an integer value, but round any other values to a maximum of two
decimals.
2DS 2(10,400)60
Q0 203.96 204 boxes
H 30
b. Determine total cost:
𝑄 𝐷 204 10,400
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 = ( ) 30 + ( ) 60 = $3,060 + $3,058.82 = $6,118.82
2 𝑄 2 204
c. Yes, annual ordering and carrying costs always are equal at the EOQ (except when rounding).
d. Determine the total cost for Q = 200 and compare to current total cost:
𝑄 𝐷 200 10,400
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 = ( ) 30 + ( ) 60 = $3,000 + $3,120 = $6,120
2 𝑄 2 200
$6,120 – $6,118.82 = $1.18 higher per year for Q = 200 (this should be acceptable).
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Chapter 12 - Inventory Management
5. Given:
D = 750 pots/mo. x 12 mo./yr. = 9,000 pots/yr.
C = $2. H = (.30)($2) = $.60/unit/year
S = $20
Note: Round the EOQ to an integer value, but round any other values to a maximum of two
decimals.
Step 1:
Determine total cost for Q = 1,500.
𝑄 𝐷 1,500 9,000
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 = ( ) . 60 + ( ) 20 = $450 + $120 = $570
2 𝑄 2 1,500
Step 2:
Determine EOQ.
2DS 2(9,000)20
Q0 774.60 775 pots
H .60
Step 3:
Determine total cost for Q = 775.
𝑄 𝐷 775 9,000
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 = ( ) . 60 + ( ) 20 = $232.50 + $232.26 = $464.76
2 𝑄 2 775
Step 4:
Determine annual savings from using the EOQ.
b. The benefit of using the EOQ is that about one half of the storage space would be needed.
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Chapter 12 - Inventory Management
6. Given:
D = 12 * 800 = 9,600
H = .35($10) = $3.50 per crate per year
S = $28
Note: Round the EOQ to an integer value, but round any other values to a maximum of two
decimals.
Step 1:
Determine current total cost for Q = 800 (the manager orders once per month).
𝑄 𝐷 800 9,600
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 = ( ) 3.50 + ( ) 28 = $1,400 + $336 = $1,736
2 𝑄 2 800
Step 2:
Determine EOQ, total cost for EOQ, and annual savings from using the EOQ.
2DS 2(9,600)28
Q0 391.92 392 crates
H 3.50
𝑄 𝐷 392 9,600
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 = ( ) 3.50 + ( ) 28 = $686 + $685.71 = $1,371.71
2 𝑄 2 392
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Chapter 12 - Inventory Management
7. Given:
Demand is projected to be 600 units for the first half of the year and 900 units for the second half.
The monthly holding cost is $2 per unit, and it costs an estimated $55 to process an order.
a. Assuming that monthly demand will be level during each six-month period, determine
an order size that will minimize the sum of ordering and carrying costs for each six-month
period:
Note: We will solve this problem using months, rather than a year, as the period.
2dS 2(100)55
Q0 74.16 74 units
H 2.00
2dS 2(150)55
Q0 90.83 91 units
H 2.00
c. If the vendor is willing to offer a discount of $10 per order for ordering in multiples of 50
units (e.g., 50, 100, 150), would you advise the manager to take advantage of the offer in
either six-month period? If so, what order size would you recommend?
Monthly TC (Q = 74):
𝑄 𝑑 74 100
( ) 𝐻 + ( ) 𝑆 = ( ) 2.00 + ( ) 55 = $74 + $74.32 = $148.32
2 𝑄 2 74
Monthly TC (Q = 50):
𝑄 𝑑 50 100
( ) 𝐻 + ( ) 𝑆 = ( ) 2.00 + ( ) 45 = $50 + $90 = $140
2 𝑄 2 50
Monthly TC (Q = 100):
𝑄 𝑑 100 100
( )𝐻 + ( )𝑆 = ( ) 2.00 + ( ) 45 = $100 + $45 = $145
2 𝑄 2 100
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Chapter 12 - Inventory Management
Monthly TC (Q = 150):
𝑄 𝑑 150 100
( )𝐻 + ( )𝑆 = ( ) 2.00 + ( ) 45 = $150 + $30 = $180
2 𝑄 2 150
Conclusion: Yes, the manager should take advantage of the offer and order Q = 50 units
during this six-month period.
Monthly TC (Q = 91):
𝑄 𝑑 91 150
( ) 𝐻 + ( ) 𝑆 = ( ) 2.00 + ( ) 55 = $91 + $90.66 = $181.66
2 𝑄 2 91
Monthly TC (Q = 50):
𝑄 𝑑 50 150
( ) 𝐻 + ( ) 𝑆 = ( ) 2.00 + ( ) 45 = $50 + $135 = $185
2 𝑄 2 50
Monthly TC (Q = 100):
𝑄 𝑑 100 150
( )𝐻 + ( )𝑆 = ( ) 2.00 + ( ) 45 = $100 + $67.50 = $167.50
2 𝑄 2 100
Monthly TC (Q = 150):
𝑄 𝑑 150 150
( )𝐻 + ( )𝑆 = ( ) 2.00 + ( ) 45 = $150 + $45 = $195
2 𝑄 2 150
Conclusion: Yes, the manager should take advantage of the offer and order Q = 100 units
during this six-month period.
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Chapter 12 - Inventory Management
8. Given:
d = 27,000 jars per month
H = $0.18 per jar per month
S = $60
Company operates 20 days a month
Current Q = 4,000
Note: Round the EOQ to an integer value, but round any other values to a maximum of two
decimals.
Step 1:
Determine current monthly cost for Q = 4,000.
𝑄 𝑑 4,000 27,000
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 = ( ) 0.18 + ( ) 60 = $360 + $405 = $765
2 𝑄 2 4,000
Step 2:
Determine EOQ, total cost for EOQ, and monthly savings from using the EOQ.
2dS 2(27,000)60
Q0 4,242.64 4,243 jars
H 0.18
𝑄 𝑑 4,243 27,000
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 = ( ) 0.18 + ( ) 60 = $381.87 + $381.81 = $763.68
2 𝑄 2 4,243
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Chapter 12 - Inventory Management
b. The manager would prefer ordering 10 times each month (every other day) but would have to
justify any change in order size. One possibility is to simplify order processing to reduce the
ordering cost. What ordering cost would enable the manager to justify ordering every other
day?
𝑄 𝑑 2,700 27,000
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 = ( ) 0.18 + ( ) 𝑆 = $765
2 𝑄 2 2,700
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Chapter 12 - Inventory Management
9. Given:
p = 5,000 hotdogs/day
u = 250 hotdogs/day
Factory operates 300 days per year
D = 250 * 300 = 75,000 hotdogs per year
S = $66
H = $0.45 per hotdog per year
Note: Round Qp to an integer value, but round any other values to a maximum of two decimals.
2 DS p 2(75,000)66 5,000
Qp 4,812.27 4,812 hotdogs
H pu 0.45 5,000 250
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Chapter 12 - Inventory Management
10. Given:
A chemical firm produces 100-pound bags. Demand for the product = 20 tons per day. The
capacity = 50 tons per day. Setup cost = $100, and storage and handling costs = $5 per ton a year.
The firm operates 200 days a year. Note: 1 ton = 2,000 pounds.
p = 50 tons per day * 2,000 pounds per ton = 100,000 pounds per day = 100,000 pounds per day /
100 pounds per bag = 1,000 bags per day
u = 20 tons per day * 2,000 pounds per ton= 40,000 pounds per day = 40,000 pounds per day /
100 pounds per bag = 400 bags per day
D = 400 bags per day * 200 days per year = 80,000 bags per year
S = $100
H = $5 per ton per year = $5 per ton per year / 20 bags per ton = $0.25 per bag per year
Note: Round Qp to an integer value, but round any other values to a maximum of two decimals.
2 DS p 2(80,000)100 1,000
a. Qp 10,327.97 10,328 bags
H pu 0.25 1,000 400
Qp 10,328
b. I max ( p u) (1,000 400) 6,196.8 bags
p 1,000
I max 6,196.8
Average Inventory = 3,098.4 bags
2 2
Qp 10,328
c. Run length = 10.33 days
p 1,000
D 80,000
d. Runs per year: 7.75 runs per year
Q 10,328
e. S = $25:
2 DS p 2(80,000)25 1,000
Qp 5,163.98 5,164 bags
H pu 0.25 1,000 400
Qp 5,164
I max ( p u) (1,000 400) 3,098.4 bags
p 1,000
𝐼𝑚𝑎𝑥 𝐷 3,098.4 80,000
𝑇𝐶(𝑆 = $25) = ( )𝐻 + ( )𝑆 = ( ) 0.25 + ( ) 25 =
2 𝑄 2 5,164
387.30 + 387.30 = $774.60
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Chapter 12 - Inventory Management
11. Given:
Assembly takes place 5 days a week, 50 weeks a year. It will take a full day to get the machine
ready for a production run of the component for the new product.
S = $300
H = $10.00
p = 200/day
u = 80/day
D = 20,000 (250 days * 80/day)
Note: Round Qp to an integer value, but round any other values to a maximum of two decimals.
How much time is available to run the other job? The job must be finished during the pure
consumption time for the component for the new product. The end of the pure consumption
time is when inventory of the component for the new product falls to 0 units. If the other job
takes longer than the pure consumption time, we will run out of inventory of the component
for the new product.
𝑄𝑝 1,414
𝐶𝑦𝑐𝑙𝑒 𝑇𝑖𝑚𝑒 = = = 17.68 𝑑𝑎𝑦𝑠
𝑢 80
This is the time between starting production runs of the component for the new product.
𝑄𝑝 1,414
𝑅𝑢𝑛 𝑇𝑖𝑚𝑒 = + 𝑆𝑒𝑡𝑢𝑝 𝑇𝑖𝑚𝑒 = + 1 = 7.07 + 1 = 8.07𝑑𝑎𝑦𝑠
𝑝 200
Plugging in values and solving for Pure Consumption Time:
𝐶𝑦𝑐𝑙𝑒 𝑇𝑖𝑚𝑒 = 𝑅𝑢𝑛 𝑇𝑖𝑚𝑒 + 𝑃𝑢𝑟𝑒 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑇𝑖𝑚𝑒
17.68 𝑑𝑎𝑦𝑠 = 8.07 𝑑𝑎𝑦𝑠 + 𝑃𝑢𝑟𝑒 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑇𝑖𝑚𝑒
𝑃𝑢𝑟𝑒 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑇𝑖𝑚𝑒 = 17.68 − 8.07 = 9.61 𝑑𝑎𝑦𝑠
Conclusion: There will not be enough time to run the other job because the other job requires
10 days, which is .39 days (10 – 9.61) days too many.
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Chapter 12 - Inventory Management
e. Three options that the manager could consider that will allow this other job to be performed:
1) Try to shorten the setup time of the component for the new product.
2) Increase the run quantity of the component for the new product to allow a longer time
between runs, i.e., run the component less often.
3) Reduce the run size of the other job.
f. Determine the additional units to produce of the component for the new product and the
increase in total annual cost from this new Q:
The Pure Consumption Time for the component for the new product must equal 10 days to
allow the other job to be run.
𝑄𝑝
𝐶𝑦𝑐𝑙𝑒 𝑇𝑖𝑚𝑒 =
𝑢
𝑄𝑝
𝑅𝑢𝑛 𝑇𝑖𝑚𝑒 = + 𝑆𝑒𝑡𝑢𝑝 𝑇𝑖𝑚𝑒
𝑝
p = 200/day, u = 80/day, and Pure Consumption Time = 10 days.
3𝑄𝑝 = 11(400)
3𝑄𝑝 = 4,400
4,400
𝑄𝑝 =
3
The additional units per run = 1,467 – 1,414 = 53 units per run.
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Chapter 12 - Inventory Management
Q = 1,467:
𝑄𝑝 1,467
𝐼𝑚𝑎𝑥 = (𝑝 − 𝑢) = (200 − 80) = 880.2 units
𝑝 200
𝐼𝑚𝑎𝑥 𝐷 880.2 20,000
𝑇𝐶(𝑄 = 1,467) = ( )𝐻 + ( )𝑆 = ( ) 10.00 + ( ) 300
2 𝑄 2 1,467
= 4,401 + 4,089.98 = $8,490.98
Q = 1,414:
12. Given:
p = 800 units per day
u = 300 units per day
Q = 2,000 units per batch
Company operates 250 days a year
c. Average Inventory:
Q 2,000
I max ( p u) (800 300) 1,250 units
p 800
𝐼𝑚𝑎𝑥 1,250
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = = = 625 units
2 2
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Chapter 12 - Inventory Management
d. The other component requires 4 days (including setup). Setup time for the heating element =
0.5 days. Is there enough time to run the other component between batches of heating
elements?
How much time is available to run the other component? The other component must be
finished during the pure consumption time for the heating element. The end of the pure
consumption time is when inventory of the heating element falls to 0 units. If the other
component takes longer than the pure consumption time, we will run out of inventory of the
heating element.
𝑄 2,000
𝐶𝑦𝑐𝑙𝑒 𝑇𝑖𝑚𝑒 = = = 6.67 𝑑𝑎𝑦𝑠
𝑢 300
This is the time between starting production runs of the heating element.
𝑄 2,000
𝑅𝑢𝑛 𝑇𝑖𝑚𝑒 = + 𝑆𝑒𝑡𝑢𝑝 𝑇𝑖𝑚𝑒 = + .5 = 2.5 + .5 = 3 𝑑𝑎𝑦𝑠
𝑝 800
Plugging in values and solving for Pure Consumption Time:
𝐶𝑦𝑐𝑙𝑒 𝑇𝑖𝑚𝑒 = 𝑅𝑢𝑛 𝑇𝑖𝑚𝑒 + 𝑃𝑢𝑟𝑒 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑇𝑖𝑚𝑒
6.67 𝑑𝑎𝑦𝑠 = 3 𝑑𝑎𝑦𝑠 + 𝑃𝑢𝑟𝑒 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑇𝑖𝑚𝑒
𝑃𝑢𝑟𝑒 𝐶𝑜𝑛𝑠𝑢𝑚𝑝𝑡𝑖𝑜𝑛 𝑇𝑖𝑚𝑒 = 6.67 − 3 = 3.67 𝑑𝑎𝑦𝑠
Conclusion: There will not be enough time to run the other component because the other
component requires 4 days, which is .33 (4 – 3.67) days too many.
13-24
Chapter 12 - Inventory Management
13. Given:
D = 18,000 boxes/year
S = $96
H = $.60/box/year
Price Schedule:
Number of Boxes Price per Box (P)
1,000-1,999 $1.25
2,000-4,999 $1.20
5,000-9,999 $1.15
10,000+ $1.10
a. Determine the optimal order quantity (round to an integer value):
Step 1:
Compute the common minimum point.
2 DS 2(18,000)96
Q 2,400 boxes
H .60
This quantity is feasible in the range 2000-4,999.
Step 2:
Determine total cost for the common minimum point and for the price breaks of all lower unit
costs.
𝑄 𝐷
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 + 𝑃𝐷
2 𝑄
2,400 18,000
TC2,400 = (.60) ($96) $1.20(18,000 ) $23,040
2 2,400
5,000 18,000
TC5,000 = (.60) ($96) $1.15(18,000) $22,545.60
2 5,000
10,000 18,000
TC10,000 = (.60) ($96) $1.10(18,000 ) $22,972 .80
2 10,000
Conclusion: Optimal order quantity = 5,000 boxes.
D 18,000
3.6 orders per year (round to a maximum of two decimals)
Q 5,000
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Chapter 12 - Inventory Management
14. Given:
D = 25 stones/day * 200 days/year = 5,000 stones/year
S = $48
Price Schedule:
Number of Stones Price per Stone (P)
1-399 $10
400-599 $9
600+ $8
2DS 2(5,000)48
Q 489.90 490 stones
H 2
This quantity is feasible in the range 400-599.
Step 2:
Determine total cost for the common minimum point and for the price breaks of all lower unit
costs.
𝑄 𝐷
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 + 𝑃𝐷
2 𝑄
490 5,000
𝑇𝐶490 = ( )2 + ( ) 48 + 9(5,000) = $45,979.80
2 490
600 5,000
𝑇𝐶600 = ( )2 + ( ) 48 + 8(5,000) = $41,000
2 600
Step 1:
Beginning with the lowest unit price, compute minimum points for each price range until you
find a feasible minimum point.
2 DS 2(5,000)48
447.21 447 Not feasible
H .30(8)
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Chapter 12 - Inventory Management
2 DS 2(5,000)48
421.64 422 Feasible
H .30(9)
Step 2:
Compare the total cost at Q = 422 to Q = 600.
𝑄 𝐷
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 + 𝑃𝐷
2 𝑄
422 5,000
𝑇𝐶422 = ( ) (.30 ∗ 9) + ( ) 48 + 9(5,000) = $46,138.42
2 422
600 5,000
𝑇𝐶600 = ( ) (.30 ∗ 8) + ( ) 48 + 8(5,000) = $41,120
2 600
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Chapter 12 - Inventory Management
15. Given:
D = 4,900
S = $50
H = 40% of purchase cost
Price Schedule:
Range Price per Unit (P)
1-999 $5.00
1,000-3,999 $4.95
4,000-5,999 $4.90
6,000+ $4.85
Step 1:
Beginning with the lowest unit price, compute minimum points for each price range until you find
a feasible minimum point.
2 DS 2(4,900)50
502.57 503 Not feasible
H .40(4.85)
2 DS 2(4,900)50
500 Not feasible
H .40(4.90)
2 DS 2(4,900)50
497.47 497 Not feasible
H .40(4.95)
2 DS 2(4,900)50
494.97 495 Feasible
H .40(5.00)
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Chapter 12 - Inventory Management
Step 2:
Compare the total cost at Q = 495 to Q = 1,000, 4,000, & 6,000.
𝑄 𝐷
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 + 𝑃𝐷
2 𝑄
495 4,900
𝑇𝐶495 = ( ) (.40 ∗ 5.00) + ( ) 50 + 5.00(4,900) = $25,489.95
2 495
1,000 4,900
𝑇𝐶1,000 = ( ) (.40 ∗ 4.95) + ( ) 50 + 4.95(4,900) = $25,490
2 1,000
4,000 4,900
𝑇𝐶4,000 = ( ) (.40 ∗ 4.90) + ( ) 50 + 4.90(4,900) = $27,991.25
2 4,000
6,000 4,900
𝑇𝐶6,000 = ( ) (.40 ∗ 4.85) + ( ) 50 + 4.85(4,900) = $29,625.83
2 6,000
Conclusion: Optimal order quantity = 495 units. Note: The total cost for 1,000 units is only $.05
different.
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Chapter 12 - Inventory Management
16. Given:
D = 800 * 12 = 9,600
S = $40
H = 25% of purchase cost
Price Schedule Supplier A:
Range Price per Unit (P)
1-199 $14.00
200-499 $13.80
500+ $13.60
We need to find the optimal quantity for each supplier and select the supplier with the minimum
cost.
Supplier A:
Step 1:
Beginning with the lowest unit price, compute minimum points for each price range until you find
a feasible minimum point.
2 DS 2(9,600)40
475.27 475 Not feasible
H .25(13.60)
2 DS 2(9,600)40
471.81 472 Feasible
H .25(13.80)
Step 2:
Compare the total cost at Q = 472 to Q = 500.
𝑄 𝐷
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 + 𝑃𝐷
2 𝑄
472 9,600
𝑇𝐶472 = ( ) (.25 ∗ 13.80) + ( ) 40 + 13.80(9,600) = $134,107.76
2 472
500 9,600
𝑇𝐶500 = ( ) (.25 ∗ 13.60) + ( ) 40 + 13.60(9,600) = $132,718
2 500
Conclusion: Optimal order quantity from Supplier A: 500 units with TC = $132,718.
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Chapter 12 - Inventory Management
Supplier B:
Step 1:
Beginning with the lowest unit price, compute minimum points for each price range until you find
a feasible minimum point.
2 DS 2(9,600)40
473.53 474 Feasible
H .25(13.70)
Step 2:
Compute total cost for Q = 474.
474 9,600
𝑇𝐶474 = ( ) (.25 ∗ 13.70) + ( ) 40 + 13.70(9,600) = $133,141.86
2 474
Conclusion: Optimal order quantity from Supplier B: 474 units with TC = $133,141.86.
Compare total cost for Q = 500 from Supplier A to total cost for Q = 474 from Supplier B:
13-31
Chapter 12 - Inventory Management
17. Given:
D = 3,600 boxes per year
Q = 800 boxes (recommended)
S = $80/order
H = $10/box/year
Price Schedule:
Range Price per Unit (P)
1-199 $1.20
200-800 $1.10
801+ $1.00
If the firm decides to order 800 boxes, the total cost is computed as follows:
𝑄 𝐷
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 + 𝑃𝐷
2 𝑄
800 3,600
𝑇𝐶800 = ( ) 10 + ( ) 80 + 1.10(3,600) = $8,320
2 800
If the firm decides to order 801 boxes, the total cost is computed as follows:
801 3,600
𝑇𝐶801 = ( ) 10 + ( ) 80 + 1.00(3,600) = $7,964.55
2 801
Even though the inventory total cost curve is fairly flat around its minimum, when there are
quantity discounts, there are multiple U shaped total inventory cost curves. Therefore, when the
quantity changes from 800 to 801, we shift to a different total cost curve.
Conclusion: The order quantity of 801 is preferred to the order quantity of 800 because the total
cost for Q = 801 is lower.
Step 1:
Compute the common minimum point.
2 DS 2(3,600)80
Q 240 boxes
H 10
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Chapter 12 - Inventory Management
Step 2:
Determine total cost for the common minimum point and for the price breaks of all lower unit
costs.
𝑄 𝐷
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 + 𝑃𝐷
2 𝑄
240 3,600
𝑇𝐶240 = ( ) 10 + ( ) 80 + 1.10(3,600) = $6,360
2 240
801 3,600
𝑇𝐶801 = ( ) 10 + ( ) 80 + 1.00(3,600) = $7,964.55
2 801
13-33
Chapter 12 - Inventory Management
18. Given:
Daily usage = 800 feet/day & lead time = 6 days.
Service level desired: 95%.
Stockout risk for various levels of safety stock:
.10 for 1,500 feet; .05 for 1,800 feet; .02 for 2,100 feet; and .01 for 2,400 feet.
Stockout risk should = 1.00 – .95 = .05. This requires a safety stock of 1,800 feet.
19. Given:
EDDLT = 300 units
dLT = 30 units
Using Appendix B, Table B, we look for the z value corresponding to 1.00 – .01 = 0.99.
The closest probability is .9901, which corresponds to z = 2.33.
ROP = 𝐸𝐷𝐷𝐿𝑇 + 𝑧𝜎𝑑𝐿𝑇 = 300 + 2.33(30) = 300 + 69.9 = 369.9 = 370 (round up)
c. Stockout risk of 2% is > 1%. Greater stockout risk = smaller z = less safety stock &
smaller ROP.
20. Given:
EDDLT = 600 lb.
dLT = 52 lb.
Stockout risk = 4%
13-34
Chapter 12 - Inventory Management
21. Given:
d = 21 gallons/week
d = 3.5 gallons/week
LT = 2 days & the dairy is open 7 days a week
Service level= 90%
Hint: Work in terms of weeks
ROP d (LT) z( d ) LT 21(2/7) 1.28(3.5) (2/7) 8.39 9 gallons (round up)
13-35
Chapter 12 - Inventory Management
c. The manager is using the ROP model described in part a. One day after placing an order with
the supplier, the manager receives a call that the order will be delayed and will arrive 3 days
from the initial order date. Two gallons have been sold since the order was placed (one day
ago).
Determine the probability of experiencing a stockout before this order arrives (in 2 days):
Risk of a stockout at the end of the initial lead time:
Using Formula 13-13, set the ROP equal to the quantity on hand 1 day after the order was
placed and solve for z:
13-36
Chapter 12 - Inventory Management
22. Given:
d = 30 gallons/day
ROP = 170 gallons
SS = 50 gallons and provides a stockout risk of 9%
Step 1:
Solve for the standard deviation of demand during the lead time.
Step 2:
Determine the SS.
13-37
Chapter 12 - Inventory Management
23. Given:
d = 85 boards/day
ROP = 625 boards
LT = 6 days
LT = 1.1 days
24. Given:
Service level = 96%
d = 12 units/day
d = 2 units/day
LT = 4 days
LT = 1 day
b. The model might not be appropriate if seasonality were present because during the busy times
of the year, the ROP would be set too low (causing stockouts) and during the slow times of
the year, the ROP would be set too high (causing excess inventory).
13-38
Chapter 12 - Inventory Management
25. Given:
LT = 4 x (1 – 0.25) = 4 x 0.75 = 3 days
S = $30
D = 4,500 gallons
H = $3
360 days/year
d = 2 gallons/day
Price List:
Quantity Unit Price
1-399 $2.00
400-799 $1.70
800+ $1.62
Step 1:
Compute the common minimum point.
2DS 2(4,500)30
Q 300 gallons
H 3
This quantity is feasible in the range 1-399.
Step 2:
Determine total cost for the common minimum point and for the price breaks of all lower unit
costs.
𝑄 𝐷
𝑇𝐶 = ( ) 𝐻 + ( ) 𝑆 + 𝑃𝐷
2 𝑄
300 4,500
𝑇𝐶300 = ( )3 + ( ) 30 + 2.00(4,500) = $9,900
2 300
400 4,500
𝑇𝐶400 = ( )3 + ( ) 30 + 1.70(4,500) = $8,587.50
2 400
800 4,500
𝑇𝐶800 = ( )3 + ( ) 30 + 1.62(4,500) = $8,658.75
2 800
4 ,500
d 12.5 / day
360
Using Appendix B, Table B, we look for the z value corresponding to 1 - .015 = .985:
z = 2.17.
13-39
Chapter 12 - Inventory Management
26. Given:
d = 5 boxes/week
d = .5 boxes/week
LT = 2 weeks
S = $2
H= $.20/box/ year
2𝐷𝑆 2(260)(2)
𝑄0 = √ =√ = 72.11 = 72 𝑢𝑛𝑖𝑡𝑠
𝐻 . 20
c. OI = 7 weeks. Determine the risk of running out before this order arrives (Q = 36) if the copy
center orders when amount on hand = 12:
13-40
Chapter 12 - Inventory Management
27. Given:
d = 80 lb./day
d = 10 lb./day
LT = 8 days
LT = 1 day
28. Given:
d = 10 rolls/day
d = 2 rolls/day
LT = 3 days
Supermarket is open 360 day a year
S = $1
H = $.40
D = 10 x 360 = 3,600
2𝐷𝑆 2(3,600)(1)
𝑄0 = √ =√ = 134.16 = 134
𝐻 . 40
b. Determine the ROP that will provide a service level of 96%:
13-41
Chapter 12 - Inventory Management
29. Given:
D = 1,200 cases
S = $40 per order
H = $3 per case per year
Service level = 99%
2𝐷𝑆 2(1,200)(40)
𝑄0 = √ 𝐻
=√ 3
= 178.89 = 179 (round to an integer value)
b. Determine the level of safety stock if lead time demand is normally distributed with a mean
of 80 cases and a standard deviation of 6 cases:
EDDLT = 80
dLT = 6
30. Given:
ROP = 18 units
Lead time for resupply = 3 days
Usage over the last 10 days:
Day 1 2 3 4 5 6 7 8 9 10
Units 3 4 7 5 5 6 4 3 4 5
Determine the service level achieved by the current ROP. Hint: Use Formula 13-13.
ROP d (LT) z( d ) LT
Step 1:
Calculate the mean and standard deviation of daily demand.
𝑑̅ = 4.6
Step 2:
Plug values into Formula 13-13 and solve for z.
18 4.6(3) z (1.265) 3
18 = 13.8 + 2.191z
4.2 = 2.191z
z = 4.2 / 2.191 = 1.92 (round to two decimals)
From Appendix B, Table B, the lead time service level is .9726 = 97.26%.
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Chapter 12 - Inventory Management
31. Given:
A drugstore uses the fixed-order-interval (FOI) model
Service Level = 98%
OI = 14 days
LT = 2 days
d = 40 units/day
d = 3 units/day
On-hand inventory in each cycle:
Cycle On Hand
1 42
2 8
3 103
Cycle 1:
Q d (OI LT ) z d OI LT A
Q 40(14 2) 2.05(3) 14 2 42
Q 622.6 = 623 units (round up)
Cycle 2:
Q 40(14 2) 2.05(3) 14 2 8
Q 656.6 = 657 units (round up)
Cycle 3:
Q 40(14 2) 2.05(3) 14 2 103
Q 561.6 = 562 units (round up)
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Chapter 12 - Inventory Management
32. Given:
Company operates 50 weeks per year
We have the following information on the two items:
P34 P35
d = 60 units/week d = 70 units/week
d = 4 units/week d = 5 units/week.
LT = 2 weeks LT = 2 weeks
Unit cost = $15 Unit cost = $20
H = (.30)($15) = $4.50 H = (.30)($20) = 6.00
S = $70 S = $30
Risk = 2.5% Risk = 2.5%
Can be ordered any time OI = 4 weeks
P34:
Using Appendix B, Table B, we look for the z value corresponding to 1 - .025 = .975:
z = 1.96.
ROP d (LT) z( d ) LT
ROP 60(2) 1.96(4) 2
ROP 120 11.09 131.09 132 units (round up)
D = 60 x 50 = 3,000 units/year
2𝐷𝑆 2(3,000)(70)
𝑄0 = √ =√ = 305.51 = 306 𝑢𝑛𝑖𝑡𝑠
𝐻 4.50
c. Compute the order quantity for P35 if 110 units are on hand at the time the order is placed:
Using Appendix B, Table B, we look for the z value corresponding to 1 - .025 = .975:
z = 1.96.
Q d (OI LT ) z d OI LT A
Q 70(4 2) 1.96(5) 4 2 110
Q 334.01 = 335 units (round up)
13-44
Chapter 12 - Inventory Management
33. Given:
We have the following list of items:
Step 1:
Determine the Annual Dollar Value (Unit Price x Estimated Annual Demand) for each item
and the sum of the individual Annual Dollar Values:
Annual
Unit Estimated Annual Dollar
Item Price Demand Value
H4-010 2.50 20,000 50,000
H5-201 4.00 60,200 240,800
P6-400 28.50 9,800 279,300
P6-401 12.00 14,500 174,000
P7-100 9.00 6,250 56,250
P9-103 22.00 7,500 165,000
TS-300 45.00 21,000 945,000
TS-400 40.00 45,000 1,800,000
TS-041 20.00 800 16,000
V1-001 4.00 33,100 132,400
3,858,750
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Chapter 12 - Inventory Management
Step 2:
Arrange the items in descending order based on Annual Dollar Values. Determine the A, B,
and C items. Then, determine the percentage of items and the percentage of Annual Dollar
Value for each category (round to two decimals).
Annual Percentage of
Dollar Percentage of Annual Dollar
Item Value Category Items Value
TS-400 1,800,000
A 20% 71.14%
TS-300 945,000
P6-400 279,300
B 20% 13.48%
H5-201 240,800
P6-401 174,000
P9-103 165,000
V1-001 132,400
C 60% 15.38%
P7-100 56,250
H4-010 50,000
TS-041 16,000
3,858,750 100.00% 100.00%
Note: An alternate solution could be to include P6-400 through V1-001 in the B category.
Unit
Estimated Annual Ordering Holding
Item Demand Cost Cost ($) EOQ
H4-010 20,000 50 .50 2,0
H5-201 60,200 60 .80 3,05
P6-400 9,800 80 8.55 428
P6-401 14,500 50 3.60 635
P7-100 6,250 50 2.70 481
P9-103 7,500 50 8.80 292
TS-300 21,000 40 11.25 386
TS-400 45,000 40 10.00 600
TS-041 800 40 5.00 113
V1-001 33,100 25 1.40 1,087
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Chapter 12 - Inventory Management
34. Given:
Demand for jelly doughnuts is shown in the table below. Labor, materials, and overhead are
estimated to be $3.30 per dozen, doughnuts are sold for $4.80 per dozen, and leftover doughnuts
are sold at half price.
Demand Relative
(dozens) Frequency
19 .01
20 .05
21 .12
22 .18
23 .13
24 .14
25 .10
26 .11
27 .10
28 .04
29 .02
𝐶𝑠 1.60
𝑆𝐿 = = = .67
𝐶𝑠 + 𝐶𝑒 1.60 + .80
Because .67 falls between the cumulative frequencies of .63 and .73, Don should stock 25 dozen
to attain a service level of at least .67. The resulting service level will be .73 = 73.00%.
13-47
Chapter 12 - Inventory Management
35. Given:
Purchase price for spare part X135 = $100 each. Carrying and disposal costs = 145% of the
purchase price. Stockout cost = $88,000. Demand for parts will approximate a Poisson
distribution with a mean of 3.2 parts.
Cs = $88,000
Ce = $100 + 1.45($100) = $245
𝐶𝑠 88,000
𝑆𝐿 = = = .997
𝐶𝑠 + 𝐶𝑒 88,000 + 245
Because .997 falls between the cumulative probabilities of .994 and .998, the optimal number
of spare parts to order = 9. The resulting service level will be .998 = 99.8%.
b. Determine the range of shortage cost for which carrying 0 spare parts would be the best
strategy:
Determine the value of Cs for which the service level = the service level of stocking 0 spare
part and solve for Cs:
𝐶𝑠 = .041(𝐶𝑠 + 245)
𝐶𝑠 = .041𝐶𝑠 + 10.045
𝐶𝑠 − .041𝐶𝑠 = 10.045
. 959𝐶𝑠 = 10.045
𝐶𝑠 = 10.47 (round to two decimals)
Conclusion: Carrying 0 spare parts is the best strategy if the shortage cost is less than or
equal to $10.47.
13-48
Chapter 12 - Inventory Management
36. Given:
Purchase price = $4.20 per pound. Selling price = $5.70 per pound. Salvage price = $2.40 per
pound. Daily demand can be approximated by a normal distribution with a mean of 80 pounds
and a standard deviation of 10 pounds.
d = 80 pounds/day
d = 10 pounds/day
𝐶𝑠 1.50
𝑆𝐿 = = = .4545
𝐶𝑠 + 𝐶𝑒 1.50 + 1.80
37. Given:
Daily demand can be approximated by a normal distribution with a mean of 40 quarts per day and
a standard deviation of 6 quarts per day. Excess cost = $.35 per quart. The grocer orders 49 quarts
per day.
d = 40 quarts/day
d = 6 quarts/day
Step 1:
Determine z value.
𝑆𝑜 − 𝑑̅ 49 − 40
𝑧= = = 1.50
𝜎𝑑 6
Using Appendix B, Table B, we find that z = 1.50 corresponds to a service level = .9332 =
93.32%.
Step 2:
Plug in .9332 and solve for Cs.
𝐶𝑠 𝐶𝑠
𝑆𝐿 = = = .9332
𝐶𝑠 + 𝐶𝑒 𝐶𝑠 + .35
𝐶𝑠 = .9332(𝐶𝑠 + .35)
𝐶𝑠 = .9332𝐶𝑠 + .327
𝐶𝑠 − .9332𝐶𝑠 = .327
. 0668𝐶𝑠 = .327
𝐶𝑠 = $4.90 per quart (round to two decimals)
b. This might be a reasonable figure because it probably is close to the lost profit per quart
during strawberry season.
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Chapter 12 - Inventory Management
38. Given:
Demand can be approximated with a Poisson distribution with a mean of 6 per day. It costs $9 to
prepare each cake. Fresh cakes sell for $12 each. Day-old cakes sell for $9 each. One half of the
day-old cakes are sold and the rest thrown out.
𝐶𝑠 3.00
𝑆𝐿 = = = .4
𝐶𝑠 + 𝐶𝑒 3.00 + 4.50
Because .4 falls between the cumulative probabilities of .285 and .446, the optimal number of
cakes to prepare = 5. The resulting service level will be .446 = 44.6%.
39. Given:
Purchase price = $1.00 per pound. Salvage value = $.80 per pound. Burgers sell for $.60 each.
Four hamburgers can be prepared from each pound of beef. Labor, overhead, meat, buns, and
condiments cost $.50 per burger. Demand is normally distributed with a mean of 400 pounds per
day and a standard deviation of 50 pounds per day. Hint: Shortage costs must be in dollars per
pound.
d = 400 pounds/day
d = 50 pounds/day
𝐶𝑠 . 40
𝑆𝐿 = = = .6667
𝐶𝑠 + 𝐶𝑒 . 40 + .20
𝑆𝑜 = 𝜇 + 𝑧𝜎 = 400 + 0.43(50) = 421.5 pounds (assuming that fractional values are possible)
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Chapter 12 - Inventory Management
40. Given:
Demand for rug cleaning machines is shown in the table below. Machines are rented by the day
only. Profit on rug cleaners = $10/day. Clyde has 4 rug-cleaning machines.
Demand Frequency
0 .30
1 .20
2 .20
3 .15
4 .10
5 .05
1.00
Cumulative
Demand Frequency Frequency
0 .30 .30
1 .20 .50
2 .20 .70
3 .15 .85
4 .10 .95
5 .05 1.00
1.00
a. Determine the implied range of excess cost per machine:
𝑆𝑜 = 4
Cs = $10
Ce = unknown
Step 1:
Set SL = .85 and solve for Ce:
𝐶𝑠 10
𝑆𝐿 = = = .85
𝐶𝑠 + 𝐶𝑒 10 + 𝐶𝑒
10 = .85(10 + 𝐶𝑒 )
10 = 8.5 + .85𝐶𝑒
10 − 8.5 = .85𝐶𝑒
1.5 = .85𝐶𝑒
𝐶𝑒 = $1.76 (round to two decimals)
Step 2:
Set SL = .95 and solve for Ce:
𝐶𝑠 10
𝑆𝐿 = = = .95
𝐶𝑠 + 𝐶𝑒 10 + 𝐶𝑒
10 = .95(10 + 𝐶𝑒 )
10 = 9.5 + .95𝐶𝑒
10 − 9.5 = .95𝐶𝑒
0.5 = .95𝐶𝑒
𝐶𝑒 = $. 53 (round to two decimals)
Conclusion: Implied range of excess cost: $.53 ≤ 𝐶𝑒 ≤ $1.76.
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Chapter 12 - Inventory Management
b. If Clyde protests that the answer from part a is too low, does this suggest an increase or a
decrease in the number of machines he stocks?
If the excess cost is supposed to be higher, then the number of machines should be decreased.
When excess cost increases, SL decreases along with the optimum stocking level.
c. Suppose now that excess cost per day = $10 and the shortage cost per day is unknown.
Assuming that the optimal number of machines is 4, what is the implied range of shortage
cost?
𝑆𝑜 = 4
Cs = unknown
Ce = $10
Step 1:
Set SL = .85 and solve for Cs:
𝐶𝑠 𝐶𝑠
𝑆𝐿 = = = .85
𝐶𝑠 + 𝐶𝑒 𝐶𝑠 + 10
𝐶𝑠 = .85(𝐶𝑠 + 10)
𝐶𝑠 = .85𝐶𝑠 + 8.5
𝐶𝑠 − .85𝐶𝑠 = 8.5
. 15𝐶𝑠 = 8.5
𝐶𝑠 = $56.67 (round to two decimals)
Step 2:
Set SL = .95 and solve for Cs:
𝐶𝑠 𝐶𝑠
𝑆𝐿 = = = .95
𝐶𝑠 + 𝐶𝑒 𝐶𝑠 + 10
𝐶𝑠 = .95(𝐶𝑠 + 10)
𝐶𝑠 = .95𝐶𝑠 + 9.5
𝐶𝑠 − .95𝐶𝑠 = 9.5
. 05𝐶𝑠 = 9.5
𝐶𝑠 = $190.00 (round to two decimals)
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Chapter 12 - Inventory Management
41. Given:
Spares cost $200 each. Unused spares have a salvage value of $50 each. If a part fails and a spare
is not available, 2 days will be needed to obtain a replacement and install it. The cost for idle
equipment is $500/day.
Probability of usage:
Number 0 1 2 3
Probability .10 .50 .25 .15
Probability of Cumulative
# of Spares Demand Probability
0 .10 .10
1 .50 .60
2 .25 .85
3 .15 1.00
Cs 1,000
SL .870
C s Ce 1,000 150
Because .870 is between the cumulative probabilities of .85 and 1.00, we need to order 3
spares.
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Chapter 12 - Inventory Management
42. Given:
Cakes cost $33 each, and they sell for $60 each. Unsold cakes are reduced to half price on
Monday, and typically one-third of those are sold. Any that remain are donated.
Probability of demand:
Number 0 1 2 3
Probability .15 .35 .30 .20
a. Use the ratio method to determine the number of cakes to prepare to maximize expected
profit:
Probability of Cumulative
# of Cakes Demand Probability
0 .15 .15
1 .35 .50
2 .30 .80
3 .20 1.00
Cs = Selling Price – Unit Cost = $60 – $33 = $27
Ce = Unit Cost – Salvage Value = $33 – [(1/3)(1/2)($60)] = $23
Cs 27
SL .54
Cs Ce 27 23
Because the service level of .54 falls between the cumulative probabilities of .50 and .80, the
supermarket should stock 2 cases of wedding cakes.
b. Use the ratio method to determine the number of cakes to prepare to maximize expected
payoff.
Expected Payoff = Expected Profit – Expected Cost
Expected Profit = Probability of Demand * Expected Profit per Cake Sold at Regular Price
($27) * Number of Cakes Sold at Regular Price.
Expected Cost = Probability of Demand * Expected Cost per Cake Left Over (Ce = $23) *
Number of Cakes Left Over.
Stocking Demand = 0 Demand = 1 Demand = 2 Demand = 3 Expected
Level Prob. = .15 Prob. = .35 Prob. = .30 Prob. = .20 Payoff
0 [Sell 0, Over 0] [Sell 0, Over 0] [Sell 0, Over 0] [Sell 0, Over 0]
(.15 * 0 * $27) – (.35 * 0 * $27) – (.30 * 0 * $27) – (.20 * 0 * $27) –
(.15 * 0 * $23) = (.35 * 0 * $23) = (.30 * 0 * $23) = (.20 * 0 * $23) =
$0 $0 $0 $0 $0
1 [Sell 0, Over 1] [Sell 1, Over 0] [Sell 1, Over 0] [Sell 1, Over 0]
(.15 * 0 * $27) – (.35 * 1 * $27) – (.30 * 1 * $27) – (.20 * 1 * $27) –
(.15 * 1 * $23) = (.35 * 0 * $23) = (.30 * 0 * $23) = (.20 * 0 * $23) =
-$3.45 $9.45 $8.10 $5.40 $19.50
2 [Sell 0, Over 2] [Sell 1, Over 1] [Sell 2, Over 0] [Sell 2, Over 0]
(.15 * 0 * $27) – (.35 * 1 * $27) – (.30 * 2 * $27) – (.20 * 2 * $27) –
(.15 * 2 * $23) = (.35 * 1 * $23) = (.30 * 0 * $23) = (.20 * 0 * $23) =
-$6.90 $1.40 $16.20 $10.80 $21.50
3 [Sell 0, Over 3] [Sell 1, Over 2] [Sell 2, Over 1] [Sell 3, Over 0]
(.15 * 0 * $27) – (.35 * 1 * $27) – (.30 * 2 * $27) – (.20 * 3 * $27) –
(.15 * 3 * $23) = (.35 * 2 * $23) = (.30 * 1 * $23) = (.20 * 0 * $23) =
-$10.35 -$6.65 $9.30 $16.20 $8.50
Conclusion: The supermarket should stock 2 cases of wedding cakes. This number of cakes
will maximize the expected payoff.
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Chapter 12 - Inventory Management
43. Given:
On average, 18 ticket holders cancel their reservations, so the company intentionally overbooks
the flight. Cancellations can be described by a normal distribution with a mean equal to 18 and a
standard deviation of 4.55. Profit per passenger = $99. If a passenger is bumped, the company
pays that passenger $200.
Cs = $99, Ce = $200
Cs 99
SL .3311
C s Ce 99 200
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Chapter 12 - Inventory Management
1. Students must recognize that without demand variability, the fixed order interval order quantity
equation reduces to:
𝑄 = 𝑑(𝐿𝑇 + 𝑂𝐼) − 𝐴
UPD places an order every 6 weeks and the lead-time is 1 week. Therefore, when the order is
placed, there will be 89 units on hand (d x LT = 1 week * 89 units/week).
Because A = 89 = d x LT, the fixed order interval order quantity equation further reduces to the
following:
2dS 2(89)(32)
Q 266.83 267 (round to an integer value)
h .08
d Q 89 267
TC EOQ S H 32 .08
Q 2 267 2
TC EOQ 10.67 10.68 $21.35 / week
The weekly total cost based on six-week fixed order interval (FOI) order quantity is given below:
d Q 89 534
TC FOI S H 32 .08
Q 2 534 2
TC FOI 5.33 21.36 $26.69 / week
Weekly savings of using EOQ rather than 6-week FOI = $26.69 – $21.35 = $5.34
The annual savings = (52 weeks) ($5.34/week) = $277.68
2. The total annual savings as a result of switching from the six-week FOI to EOQ are relatively
small and switching to the optimal order quantity may not be warranted. However, if the FOI
approach is used with other parts or components as well, the total potential loss may be
significant.
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Chapter 12 - Inventory Management
1. Computerize the inventory control system. Rationale: There are too many parts for the current
manual system.
2. Currently, no paperwork is used when items are withdrawn from the stockroom when they are
needed on the shop floor. Harvey Industries may either want to establish a procedure for
recording the transactions in the stockroom or invest in a bar coding system. If a bar coding
system is purchased, it has to be coordinated with the new computerized inventory control
system. Establishing a cycle counting procedure may be very helpful also. Rationale: As a result
of these actions, the inventory accuracy should improve substantially.
3. It appears that utilization of A-B-C inventory classification system is needed. Rationale: Harvey
Industries rarely should experience stockouts in those “A” items that account for $220,684 of
$314,673 in annual purchases or for any “A” items for which a stockout leads to significant
downtime costs. ABC analysis will allow Harvey Industries to establish an appropriate degree of
control over items in terms of order quantity and ordering frequency.
Case: Grill Rite
Recommendations:
1. The president’s stance on steady output conflicts with seasonal demand. However, it is unlikely
that this will change. One alternative might be to identify a complementary product that would
offset seasonal demand for electric grills.
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Chapter 12 - Inventory Management
2. A fixed-interval ordering system is appropriate given that the manager reviews inventory and
places orders once a week from the supplier.
3. Given:
SL = 95%
𝑑̅ = 35 units/week
𝜎𝑑 = 3.5 units/week
Gravy mix comes in packs of 2
There are currently 3 packs in inventory = 6 units
LT = 2 days = 2/7 weeks
OI = 1 week
Using z = 1.64:
Q d (OI LT ) z d OI LT A
Q 35(1 2 / 7) 1.64(3.5) 1 2 / 7 6
Q 45.51 = 46 units (round up) = 23 of the 2-packs.
Using z = 1.65:
Q d (OI LT ) z d OI LT A
Q 35(1 2 / 7) 1.65(3.5) 1 2 / 7 6
Q 45.55 = 46 units (round up) = 23 of the 2-packs.
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Chapter 12 - Inventory Management
4. Given:
A = 12
Determine the risk of a stockout at the end of the initial lead time and at the end of the second
lead time:
Use Formula 13-13 to determine the risk of stockout at the end of the initial lead time:
Determine the risk of a stockout at the end of the second lead time:
Use Formula 13-16 to determine the risk of stockout at the end of the second lead time:
Q d (OI LT ) z d OI LT A
46 35(1 2 / 7) z (3.5) 1 2 / 7 12
46 45 3.969z 12
46 33 3.969z
13 3.969z
𝑧 = 3.28 (round to two decimals)
Using Appendix B, Table B, we look for the corresponding service level: .9995.
The risk of a stockout = 1 - .9995 = .0005 = .05%.
5. Kristin may want to consider dealing with a nearby supplier to be able to order more frequently or
to reduce transportation costs. In addition, if she ordered from a nearby supplier, she could have
the option of sending an employee to the supplier’s facility to pick up emergency orders. On the
other hand, she may want to keep her current supplier due to competitive prices and/or
exceptional customer service.
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Chapter 12 - Inventory Management
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Chapter 12 - Inventory Management
Problem
A company produces plastic powder in lots of 2,000 pounds, at the rate of 250 pounds per hour. The
company uses powder in an injection molding process at the steady rate of 50 pounds per hour for an
eight-hour day, five days a week. The manager has indicated that the setup cost is $100 for this product,
but “We really have not determined what the holding cost is.”
a. What weekly holding cost per pound does the lot size imply, assuming the lot size is optimal?
b. Suppose the figure you compute for holding cost has been shown to the manager, and the
manager says that it is not that high. Would that mean the lot size is too large or too small?
Explain.
Solution to Enrichment Module Problem
a.
Q 2,000 lbs.
p 250 lbs. / hr.
u 50 lbs. / hr.
S $100
d (50 lbs. / hr.) x (8 hrs. / day ) x (5 days / week ) 2,000 lbs. / week
2dS p
Q x
H p u
2(2,000)(100) 250
2,000 x
H 250 50
400,000
2,000 x(1.25)
H
500,000
2,000
H
500,000
(2,000) 2
H
500,000
H $.125 / lb. / week
4,000,000
b. Decreasing the value of carrying cost (H) will result in an increase in the lot size.
Because holding inventory is not as expensive, the firm could afford to carry more
inventory and therefore produce a larger batch.
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Chapter 12 - Inventory Management
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Chapter 12 - Inventory Management
A large local car dealership orders a certain brand of automobiles from a car manufacturer located in
Detroit. Order quantity (Q) is 500 units, annual demand (D) is 7,500 and the firm operates 300 working
days per year. Due to the high holding costs, the company plans to backorder (B) 200 cars per order cycle.
Determine the average inventory.
d = (D/number of operational days) = 7,500/300 = 25 units (daily consumption)
T = Q/d = 500/25 = 20 days (time between orders is 20 days)
t1 = (Q – B)/d = (500 – 200)/25 = 300/25 = 12 days (time period during which there is no shortage)
t2 = B/d = 200/25 = 8 days (time period during which there is no inventory)
The dealership will carry an average of (Q – B)/2 units during t1 and no units during t2. Therefore, total
number of unit days during the inventory cycle can be computed by multiplying t1 by (Q – B)/2
QB
Number of unit days of inventory/cycle t1 *
2
(Q B) (Q B)
Number of unit days of inventory/cycle
d 2
(Q B) 2
2d
In other words, an average of 150 units are carried in inventory for 12 days and zero units are carried for 8
days (shortage period). Therefore, total number of unit days of inventory during the complete order cycle
is (150)(12) = 1800.
Because there are a total of 20 days in the complete order cycle, the average inventory can be computed
by dividing the total number of unit days of inventory by the number of days in the inventory cycle. In
this example, the average inventory is equal to 1,800/20 or 90 units. Therefore, the average inventory can
be computed by using the following formula:
(Q B) 2
Average inventory 2d
Q
d
(Q - B) 2
Average inventory
2Q
Using a similar logic, we can also develop the average backlog formula. The dealership will experience
shortage (backorders) for 8 days during the order cycle. The average amount of backorder on a given
shortage day is B/2. Based on this information, the total number of backorder unit days can be computed
using the following equation: (t2) (B/2) = (B/D)(B/2) = B2 /2D.
In our example, there are 8 days of a planned shortage period. During this period, an average of 200/2 =
100 units of backorders are realized. Therefore, the total number of backorder unit days during the order
cycle is (8)(100) = 800 units. Because there are a total of 20 days in the order cycle, the average
backorder quantity for the complete order cycle can be determined by dividing the total number of
backorder unit days by the number of days in the complete inventory cycle. In this example, using the
above equation, we obtain an average backorder quantity of 800/20 = 40 units. The general equation for
the average backorder quantity is:
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Chapter 12 - Inventory Management
B2
Average backorder 2d
Q
d
B2
Average backorder
2Q
Annual inventory carrying cost still is calculated by multiplying the average inventory by the inventory
carrying cost per unit per year. The formula for the annual ordering cost is the same as it was for the basic
EOQ model. The annual backorder cost is determined by multiplying the average backorder quantity by
the backorder cost per unit per year.
The annual inventory carrying cost is given by:
(Q B) 2
H
2Q
The annual ordering and backordering costs are given by the following respective formulas:
D
S
Q
B2
CB
2Q
Therefore, the total annual inventory cost (TC) can be expressed by summing the annual inventory
carrying cost, the annual ordering cost, and the annual backordering cost as shown in the following
formula:
(Q B) 2 D B2
TC H S CB
2Q Q 2Q
Taking the first total derivative of the above total cost formula with respect to Q, setting the resulting
equation to zero, and solving for Q will result in the following optimal quantity (Q*) and optimal
backorders (planned shortages) (B*) formulas:
2 DS H C B
Q*
H C B
H
B* Q *
H B
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Chapter 12 - Inventory Management
Figure 1
An inventory situation with planned shortages
Inventory
Maximum Inventory Level
Q–B
Stockout B Time
QB
t1
d t2
T = Q/d
Example:
XYZ Company distributes a major part for the F–15 fighter jets. Due to the very high holding cost, the
company wants to implement a model with planned shortages. The annual demand is 81,000 and the
company operates 300 days per year. The annual carrying cost rate is 10% of the unit cost and the unit
cost of this item is $1,000. The ordering cost per batch is estimated at $500.
a. Determine the optimal order quantity and total annual inventory cost (ordering cost + carrying
cost) using the basic EOQ model with no backorders.
b. If each unit backordered costs the company $200 per unit per year, what would be the optimal
order quantity and the optimal size of the planned backorder?
c. Determine the annual carrying cost, the annual ordering cost, the annual backordering cost, and
the annual total inventory cost for the planned shortage model used in part b.
d. Determine the values of t1, t2 and T in days.
e. Should the company adopt the planned backorder model of part b or the basic EOQ model of part
a, which does not allow backorders?
D = 81,000 units
S = $500
d = 81,000/300 days = 27 units per day
H = ($1,000) (.10) = $100
CB = $200
2DS 2(81,000 )(500 )
a. Q* Q* 900
H 100
D 81,000
Annual ordering cost = S (500 ) 45,000
Q 900
Q 900
Annual carrying cost = H (100) 45,000
2 2
Total annual cost = $45,000 + $45,000 = $90,000
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Chapter 12 - Inventory Management
b.
2 DS ( H C B )
Q*
H C B
2(81,000)(500) 100 200
Q*
100 200
Q * 1,215,000 1,102.3 1,102
H
B Q *
H CB
100
B (1,102) 367.33 367
100 200
c.
(Q B ) 2
Annual carrying cost H
2Q
(1,102 367) 2
(100)
2(1,102)
24,511.12
D 81,000
Annual ordering cost ( S ) (500)
Q 1,102
36,751.36
B2
Annual backorderi ng cost C B
2Q
367 2
(200) 12,222.23
2(1,102)
Let TC = Total annual inventory cost
TC = $24,511.12 + $36,751.36 + $12,222.23 = $73,484.71
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Chapter 12 - Inventory Management
d.
81,000
d 27
300
Q 1,102
T 40.81 days
d 27
Q B 1,102 367
t1 27.22 days
d 27
B * 367
t2 13.59 days
d 27
e. The model with planned backorders is preferred because the total annual inventory cost of the
basic EOQ inventory model is substantially higher than the total annual inventory cost of the
planned backorder model.
TCbasic EOQ = $90,000
TCbackorder = $73,484.71
$90,000 – $73,484.71 = $16,515.29 difference
Problems
The manager of an inventory system believes that inventory models are important decision-making aids.
Although the manager often uses an EOQ policy, he has never considered a backorder model because of
his assumption that backorders are “bad” and should be avoided. However, with upper management’s
continued pressure for cost reduction, you have been asked to analyze the economics of a backordering
policy for some products that possibly can be backordered. For a specific product with D = 800 units per
year, S = $150, H = $10, and CB = $20, what is the cost difference in the EOQ and the planned shortage or
backorder model? If the manager adds constraints that no more than 35% of the units may be backordered
and that no customer will have to wait more than 20 days for an order, should the backorder inventory
policy be adopted? Assume 250 working days per year.
Solution to Problem
D = 800 units/year
S = $150
H = $10/unit/year
CB = $20/unit/year
Planned shortage model:
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Chapter 12 - Inventory Management
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