CH 13 Invmgthwsoln

Chapter 13 - Inventory Management
CHAPTER 13
INVENTORY MANAGEMENT
Answers to Discussion and Review Questions

1.
Inventories are held (1) to take advantage of price discounts, (2) to take advantage of
economic lot sizes, (3) to provide a certain level of customer service, and (4) because production
requires some in-process inventory.
2.
Effective inventory management requires (1) cost information, information on demand
and lead time (amounts and variabilities), an accounting system, and a priority system (e.g., A-BC).
3.
Carrying or holding costs include interest, security, warehousing, obsolescence, and so
on. Procurement costs relate to determining how much is needed, vendor analysis, inspection of
receipts and movement to temporary storage, and typing up invoices. Shortage costs refer to
opportunity costs incurred through failure to make a sale due to lack of inventory. Excess costs
refer to having too much inventory on hand.
13-1
4.
The RFID (Radio Frequency Identification) chip tags are beginning to be used with
consumer products and they contain bits of data, such as product serial number. Scanners will
automatically read the information on an RFID chip into a database, so the companies can keep
track of sales and inventory. Keeping track of inventory will enable suppliers to keep track of
trends and react to market changes. In addition, RFID chips will assist in increasing the speed of
communication on a supply chain. The information between parties will travel faster, which will
improve the responsiveness of buyers and ordering information on the supply chain. The risk of
using RFID chip tags stems from privacy concerns. It is feared that computer pirates will figure
out security controls and be able to scan shoppers merchandise and determine what they have
bought. In order to avoid this risk, companies are considering turning of RFID tags once the items
are purchased.
5.
It may be inappropriate to compare the inventory turnover ratios of companies in
different industries because the production process, requirements and the length of production run
varies across different industries. The shorter the production time, the less the need for inventory.
In addition, the material delivery lead times may vary between different industries. The higher the
variability of lead time and the longer the lead time, the greater the need for inventory. As
supplier reliability increases, the need for inventory decreases. The industries with higher forecast
accuracies have less of a need for inventories.
6.
a. Only one product is involved.
b. Annual demand requirements are known.

c. Demand is spread evenly throughout the year so that the demand rate is reasonably constant.
d. Lead time does not vary.
e. Each order is received in a single delivery.
f. There are no quantity discounts
7.
The total cost curve is relatively flat in the vicinity of 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, in
order 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.
Safety stock is large when large variations in lead time and/or usage are present.
Conversely, small variations in usage or lead time require small safety stock. Safety stock is zero
when usage and lead time 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 the amount on hand. Other definitions relate to the
percentage of cycles per year without a stockout, or the percentage of annual demand satisfied
from inventory. (This last definition often tends to confuse students in my experience.)
Increasing the service level requires increasing the amount of safety stock.
13-2
12.
The A-B-C approach refers to the classification of items stocked according to some
measure of importance (e.g., cost, cost-volume, criticalness, cost of stockout) and allocating
control efforts on that basis.
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 (fewer
orders), but increased carrying costs. Since 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 may also be a factor.
14.
Annual carrying costs are determined by average inventory. Hence, a decrease in average
inventory is desirable, if possible. Average inventory is Q o/2, and Qo decreases (run size model) if
setup cost, S, decreases.
15.
The Single-Period Model is used when inventory items have a limited useful life (i.e.,
items are not carried over from one period to the next).
16.
Yes. When excess costs are high and shortage costs are low, the optimum stocking level
is less than expected demand.
17.
A company can reduce the need for inventories by:

a. using standardized parts
b. improved forecasting of demand
c. using preventive maintenance on equipment and machines
d. reducing supplier delivery lead times and delivery reliability
e. utilizing reliable suppliers and improving the relationships 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 a per unit purchasing cost of the item. We will also save on
ordering cost because since we bought a larger quantity, we will not have to order this item as
frequently. However, as a result of ordering larger quantity, 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, as the unit price increases, so will
the holding cost, and as a result, if we are using the EOQ approach, we will have to place a
smaller order, resulting in a lesser 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.
13-3
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 would also lead to less 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 assurance of
material availability.
2.
In making inventory decisions involving holding costs, setting inventory levels and deciding on
quantity discount purchases, the materials manager, plant manager, production planning and
control manager, the purchasing manager, and in some cases the planners who work in production
planning and control or purchasing departments should be involved. The level and the nature of
involvement will depend on the organizational structure of the company and the type of product
being manufactured or purchased.
3.
The technology has had a tremendous impact on inventory management. The utilization of bar
coding has not only reduced the cost of taking physical inventory but also enabled real time
updating of inventory records. The satellite control systems available in trucks and automobiles
has enabled companies to determine and track the location of in-transit inventory.
Critical Thinking Exercise

1.
2.
3.
Including a wider range of foods provide fast food companies with a competitive edge in terms of
improving customer satisfaction and service. However, it has also complicated the operational
function of the company. Expansion of menu offerings can create problems for inventory
management because there are more ingredients and inventory items to order and to control the
levels of inventory. This means higher labor costs in terms of placing orders, increased storage
facility needs and increased need for coordinating the shipments from the supplier so that
deliveries can be at low cost and efficient. Increasing the variety of items on the menu will also
cause problems with forecasting. Since we have more items on the menu, it is likely that the
demand for current menu items will decrease. The 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.
a. How important is the item? For example, does it relate to a holiday or other important event,
such as graduation cards?
b. Are comparable substitutes readily available?
c. What competitor alternatives are available to customers?
d. Is this an occasional occurrence, or indicative of a larger, perhaps ongoing, problem?
Among considerations are:
How many stamps does he now have? Does he know how many he has? If so, how many?
What is his usage rate or current need for stamps?
What else does he need the cash for today?
Can he get more money at a bank or ATM?
How long will it be before he will return to the post office?
Will the post office be closed for a holiday or a Sunday?
Can he buy stamps elsewhere in case he runs low?
How convenient is it for him to visit the post office?
13-4
Can he purchase forever stamps and temporarily avoid a price increase?

4.
Student answers will vary.
Memo Writing Exercises

1.
Cost of carrying inventory must be weighted against the following costs:

a. cost of shortages (finished goods inventory)
b. cost of failures (work-in-process inventory)
c. cost of supplier reliability
d. cost of ordering
e. cost of setups
f.
cost of quantity discounts
g. cost of smoothing production for seasonal products.

2.
The possible advantages of using a single supplier include:

a. obtaining a discount due to additional volume purchased from the supplier
b. building trust and working with the supplier so that the material will be delivered in a timely
fashion to avoid stockouts and excess inventory.
The possible advantages of using multiple suppliers include:
a. the adverse effect of tardiness will be felt much less when there are multiple sources for the
materials.
The main advantage of using the fixed order interval model is the reduction in ordering cost
because orders for different parts are aggregated during the order interval.
The main disadvantage of using the fixed order interval model is that the company faces the
risk of experiencing shortages during the fixed interval.
In this particular situation, the advantages of using a single supplier may be offset by using
the fixed order interval model.
13-5
Solutions
1. a.
Item
4021
Usage
90
Unit Cost
$1,400
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
25,000
In descending order:
Item
Usage x Cost
4021
$126,000
Usage x Unit Cost

$126,000
Category
A
4400
25,000
4066
21,000
6850
20,000
4050
11,200
9280
10,200
3010
8,000
9402
3,600
6500
3,000
228,000
1. b.
Category
A
B
C
Percent of Items
11.1%
33.3%
55.6%
Percent of Total Cost

55.3%
28.9%
15.8%
13-6
Category
A
2.
The following table contains figures on the monthly volume and unit costs for a random
sample of 16 items for a list of 2,000 inventory items.
Item
K34
K35
K36
M10
M20
Z45
F14
F95
F99
D45
D48
D52
D57
N08
P05
P09
a.
b.
Dollar
Unit Cost Usage Usage Category
10
200
2,000
C
25
600
15,000
A
36
150
5,400
B
16
25
400
C
20
80
1,600
C
80
250
16,000
A
20
300
6,000
B
30
800
24,000
A
20
60
1,200
C
10
550
5,500
B
12
90
1,080
C
15
110
1,650
C
40
120
4,800
B
30
40
1,200
C
16
500
8,000
B
10
30
300
C
Develop an A-B-C classification for these items. [See table.]
How could the manager use this information? To allocate control efforts.
c.
It might be important for some reason other than dollar usage, such as cost of a
stockout, usage highly correlated to an A item, etc.
3.
D = 1,215 bags/yr.
S = $10
H = $75
a.
2 DS
2(1,215)10
18 bags
75
b. Q/2 = 18/2 = 9 bags

c.
D
1,215 bags
67.5 orders
Q 18 bags / orders
13-7
TC Q / 2H
d.
D
S
Q
18
1,215
(75)
(10) 675 675 $1,350
2
18
e. Assuming that holding cost per bag increases by $9/bag/year

Q=
2(1,215)(10)
17 bags
84
TC
17
1,215
(84)
(10) 714 714.71 $1,428.71
2
17
Increase by [$1,428.71 $1,350] = $78.71
4.
D = 40/day x 260 days/yr. = 10,400 packages

S = $60 H = $30
a.
Q0
2DS
b.
TC
Q
D
H S
2
Q
2(10,400)60
203.96 204 boxes
30
204
10,400
(30)
(60) 3,060 3,058.82 $6,118 .82
2
204
c. Yes
d.
TC 200
200
10,400
(30)
(60)
2
200
TC200 = 3,000 + 3,120 = $6,120

6,120 6,118.82 (only $1.18 higher than with EOQ, so 200 is acceptable.)
13-8
5.
D = 750 pots/mo. x 12 mo./yr. = 9,000 pots/yr.

Price = $2/pot S = $20 H = ($2)(.30) = $.60/unit/year
a.
Q0
TC
2DS
2(9,000) 20
774.60 775
.60
774.6
9,000
(.60)
(20)
2
774.6
TC = 232.35 + 232.36
= 464.71
If Q = 1500
TC
1,500
9,000
(.6)
( 20)
2
1,500
TC = 450 + 120 = $570

Therefore the additional cost of staying with the order size of 1,500 is:
$570 $464.71 = $105.29
b.
6.
Only about one half of the storage space would be needed.
u = 800/month, so D = 12(800) = 9,600 crates/yr.

H = .35P = .35($10) = $3.50/crate per yr.
S = $28
Present TC :
a.
Q0
800
9,600
(3.50)
( 28) $1,736
2
800
2DS
TC at EOQ:
2(9,600)$28
391.93 [ round to 392]
$3.50
392
9,600
(3.50)
( 28) $1,371.71. Savings approx. $364.28 per year.
2
392
13-9
7.
H = $2/month
S = $55
D1 = 100/month (months 16)
D2 = 150/month (months 712)
a.
Q0
2DS
H
D1 : Q 0
2(100)55
74.16
2
D2 : Q0
2(150)55
90.83
2
b. The EOQ model requires this.

c. Discount of $10/order is equivalent to S 10 = $45 (revised ordering cost)
16
TC74 =
$148.32
TC 50
50
100
( 2)
( 45) $140 *
2
50
TC 100
100
100
( 2)
( 45) $145
2
100
TC 150
150
100
( 2)
( 45) $180
2
150
712 TC91 =
$181.66
TC 50
50
150
( 2)
( 45) $185
2
50
TC100
100
150
( 2)
( 45) $167.5 *
2
100
TC150
150
150
( 2)
( 45) $195
2
150
13-10
8.
D = 27,000 jars/month
H = $.18/month
S = $60
a.
2DS
TC=
Q
D
H
S
2
Q
2( 27,000)60
4,242.64 4,243.
.18
TC4,000 = $765.00
$736.67
Difference
$1.32
TC4,243 =
27,000
4,000
(60) 765
(.18)
2
4,000
TC4000 =
27,000
4,243
60 763.68
(.18)
2
4,243
TC4243 =
D
27,000
6.75
Q
4,000
b. Current:
For
D
to equal 10, Q must be 2,700
Q
2DS
So 2,700
H
2(27,000)S
.18
Solving, S = $24.30
c. the carrying cost happened to increase rather dramatically from $.18 to approximately
$.3705.
2DS
2(27,000)50
Q
2,700
H
H
Solving, H = $.3705
13-11
9.
p = 5,000 hotdogs/day
u = 250 hotdogs/day
D= 250/day x 300 days/yr. = 75,000 hotdogs/yr.
300 days per year

S = $66
H = $.45/hotdog per yr.
a.
2DS
H
Q0
pu
2(75,000)66
.45
5,000
4,812.27 [round to 4,812]
4,750
b. D/Qo = 75,000/4,812 = 15.59, or about 16 runs/yr.

c. run length: Qo/p = 4,812/5,000 = .96 days, or approximately 1 day
10.
p = 50/ton/day
u = 20 tons/day
D= 20 tons/day x 200 days/yr. = 4,000 tons/yr.
200 days/yr.
S = $100
H = $5/ton per yr.
a.
Q0
2DS
H
b.
I max
Q
516.4
(p u )
(30) 309.84 tons [approx. 6,196.8 bags]
P
50
Average is
pu
2(4,000)100
5
50
516.40 tons [10,328 bags]
50 20
I max 309.48
:
154.92 tons [approx. 3,098 bags]
2
2
c. Run length =
Q 516.4
10.33 days
P
50
d. Runs per year:
D
4,000
7.75 [approx. 8]
Q
516.4
e. Q = 258.2
TC =
I max
D
H S
2
Q
TCorig.
= $1,549.00
TCrev.
= $ 774.50
Savings would be $774.50
13-12
11.
S = $300
D = 20,000
(250 x 80 = 20,000)
H = $10.00
p = 200/day
u = 80/day
a.
Q0
2DS
H
pu
2( 20,000)300
10
200
200 80
Q0 = (1,095.451) (1.2910) = 1,414 units

b. Run length =
Q 1,414
7.07 days
P
200
c. 200 80 = 120 units per day

d.
I max
Q
1,414
(p u )
( 200 80) 848.0 units
P
200
848 80/day = 10.6 days

- 1.0 setup
9.6 days
No, because present demand could not be met.
e. 1) Try to shorten setup time by .40 days.
2) Increase the run quantity of the new product to allow a longer time between runs.
3) Reduce the run size of the other job.]
f.
In order to be able to accommodate a job of 10 days, plus one day for setup, there would
need to be an11 day supply at Imax, which would be 880 units on hand. Solving the
following for Q, we find:
Q
Q
I max ( p u )
( 200 80) 880 units
P
200
Q = 1,467.
Using formula 13-4 for total cost, we have
TC @ 1,467 units = $8,489.98
TC @ 1,414 units = $8,483.28
Additional cost =
$6.70
13-13
12.
p = 800 units per day

d = 300 units per day
Q0 = 2000 units per day
a. Number of batches of heating elements per year =
75,000
37.5 batches per year
2,000
b. The number of units produced in two days = (2 days)(800 units/day) = 1600 units
The number of units used in two days = (2 days) (300 units per day) = 600 units
Current inventory of the heating unit = 0
Inventory build up after the first two days of production = 1,600 600 = 1,000 units
Total inventory after the first two days of production = 0 + 1,000 = 1,000 units.
c. Maximum inventory or Imax can be found using the following equation:
pd
p
I max Q0
800 300
2,000
(2,000)(.625) 1,250 units
800
Average inventory
I max 1,250
625 units
2
2
d. Production time per batch =
Q 2 ,000
2.5 days
P
800
Setup time per batch = day

Total time per batch = 2.5 + 0.5 = 3 days
Since the time of production for the second component is 4 days, total time required for both
components is 7 days (3 + 4). Since we have to make 37.5 batches of the heating element per
year, we need (37.5 batches) x (7 days) = 262.5 days per year.
262.5 days exceed the number of working days of 250, therefore we can conclude that there
is not sufficient time to do the new component (job) between production of batches of heating
elements.
An alternative approach for part d is:
The max inventory of 1,250 will last 1250/300 = 4.17 days
4.17 .50 day for setup = 3.67 days. Since 3.67 is less than 4 days, there is not enough time.
13-14
13.
D = 18,000 boxes/yr.
S = $96
H = $.60/box per yr.
a.
Qo =
2DS
2(18,000)96
2,400 boxes
.60
Since this quantity is feasible in the range 2000 to 4,999, its total cost and the total cost of all
lower price breaks (i.e., 5,000 and 10,000) must be compared to see which is lowest.
TC2,400 =
2,400
18,000
(.60)
($96) $1.20(18,000) $23,040
2
2,400
TC5,000 =
5,000
18,000
(.60)
($96) $1.15(18,000) $22,545.6 [lowest ]
2
5,000
TC10,000 =
10,000
18,000
(.60)
($96) $1.10(18,000) $22,972.80
2
10,000
Hence, the best order quantity would be 5,000 boxes.
Lowest TC
TC
2,400
b.
5,000
D 18,000
3.6 orders per year

Q
5,000
13-15
10,000
Quantity
14.
a.
S = $48
D = 25 stones/day x 200 days/yr. = 5,000 stones/yr.
Quantity
1 399
400 599
600 +
TC490 =
Unit Price
$10
9
8
a. H = $2
2DS
2(5,000)48
489.90
2
490
5,000
2+
48 + 9 (5,000) = $45,980
2
490
600
5,000
2+
48 + 8 (5,000) = $41,000
2
600
600 is optimum.
TC600 =
b. H = .30P
EOQ $8
2(5,000) 48
447 NF
.30(8)
TC
( Not feasible at $8/stone)

EOQ $9
2(5,000) 48
422
.30(9)
422
447 600
(Feasible)
Compare total costs of the EOQ at $9 and lower curves price break:
Q
D
TC =
(.30P) +
(S) +PD
2
Q
TC422 =
422
[.30($9)] +
2
Quantity
5,000
($48) + $9(5,000) = $46,139
422
600
5,000
[.30($8)] +
($48) + $8(5,000) = $41,120
2
600
Since an order quantity of 600 would have a lower cost than 422, 600 stones is
the optimum order size.
c. ROP = 25 stones/day (6 days) = 150 stones.
TC600 =
13-16
15.
D = 4,900 seats/yr.
H = .4P
S = $50
Range
0999
1,0003,999
4,0005,999
6,000+
P
$5.00
4.95
4.90
4.85
H
$2.00
1.98
1.96
1.94
Q
495
497 NF
500 NF
503 NF
Compare TC495 with TC for all lower price breaks:

495
4,900
TC495 =
($2) +
($50) + $5.00(4,900) = $25,490
2
495
1,000
4,900
TC1,000 =
($1.98) +
($50) + $4.95(4,900) = $25,490
2
1,000
4,000
4,900
TC4,000 =
($1.96) +
($50) + $4.90(4,900) = $27,991
2
4,000
6,000
4,900
TC6,000 =
($1.94) +
($50) + $4.85(4,900) = $29,626
2
6,000
Hence, one would be indifferent between 495 or 1,000 units
TC
495 497 500 503
1,000
4,000
Quantity
13-17
6,000
16.
D = (800) x (12) = 9600 units
S = $40
H = (25%) x P
For Supplier A:
Q13.6
2( 9 ,600 )( 40 )
475.27 ( not feasible )
(.25 )( 13.6 )
Q13.8
2( 9 ,600 )( 40 )
471.81
(.25 )( 13.8 )
9 ,600
471.81
( 40 ) [( 13.8 )( 9 ,600 )]
3.45
2
471.81
813.88 813.87 132 ,480
TC 471.81
TC 471.81
TC 471.81 $134 ,107.75

9 ,600
500
( 40 ) [( 13.6 )( 9 ,600 )]
(.25 )( 13.6 )
500
2
768 850 130 ,560
TC 500
TC 500
TC 500 $132 ,178 *
For Supplier B:
Q13.7
2( 9 ,600 )( 40 )
473.53
(.25 )( 13.7 )
9 ,600
473.53
( 40 ) [( 13.7 )( 9 ,600 )]
(.25 )( 13.7 )
2
473.53
810.93 810.92 131,520
TC 471.81
TC 471.81
TC 471.81 $133 ,141.85
Since $132,178 < $133,141.85, choose supplier A.

The optimal order quantity is 500 units.
13-18
17.
D = 3600 boxes per year

Q = 800 boxes (recommended)
S = $80 /order
H = $10 /order
If the firm decides to order 800, the total cost is computed as follows:
D
Q
S ( P * D)
H
2
Q
TC
800
3,600
$10
$80 (3,600 x 1.1)
2
800
TC Q 800
TC Q 800 4,000 360 3,960 8,320
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 for each unit price
depending on the unit price. Therefore when the quantity changes from 800 to 801, we shift to a
different total cost curve.
If we take advantage of the quantity discount and order 801 units, the total cost is computed as
follows:
D
Q
S ( P * D)
H
2
TC
801
3,600
$10
$80 (3,600 x 1.0)
2
801
TC Q 801
TC Q 801 4,005 359.55 3,600 7,964.55
The order quantity of 801 is preferred to order quantity of 800 because TC Q=801 < TCQ=800 or
7964.55 < 8320.
2DS
EOQ
2(3,600)(80)
240 boxes
10
D
Q
S ( P * D)
H
2
Q
TC EOQ
240
3,600
$10
$80 (3,600 x 1.1)
2
240
TC EOQ
TC EOQ 1,200 1,200 3,960 6,360
The order quantity of 800 is not around the flat portion of the curve because the optimal order
quantity (EOQ) is much lower than the suggested order quantity of 800. Since the EOQ of 240
boxes provides the lowest total cost, it is the recommended order size.
13-19
18.
Daily usage = 800 ft./day Lead time = 6 days

Service level desired: 95 percent. Hence, risk should be 1.00 .95 = .05
This requires a safety stock of 1,800 feet.
ROP = expected usage + safety stock
= 800 ft./day x 6 days + 1,800 ft. = 6,600 ft.
19.
Expected demand during LT = 300 units

dLT = 30 units
a. Z = 2.33, ROP = exp. demand + ZdLT
300 + 2.33 (30) = 369.9 = 370 units
b. 70 units (from a.)
c. smaller Z = less safety stock
ROP smaller:
20.
LT demand = 600 lb.

dLT = 52 lb.
risk = 4% Z = 1.75
a. ss = ZdLT = 1.75 (52 lbs.) = 91 lbs.
b. ROP = Average demand during lead time + safety stock
ROP = 600 + 91 = 691 lbs.
c. With no safety stock risk is 50%.
21.
(
d
LT
SL
a.
b.
= 21 gal./wk.
= 3.5 gal./wk.
= 2 days
= 90 percent requires z = +1.28
90%
0
1.28
z-scale
8.39
gallons
ROP d (LT) z LT ( d ) 21(2/7) 1.28 (2/7) (3.5) 8.39 gallons
10 2
Q d (OI LT ) Z d OI LT A 21
1.28(3.5) 12 / 7 8 33.87
7 7
or approx. 34 gal./wk.
Average demand per day = 21 gallons / 7days per week = 3 gallons

= Average demand during lead time = (3 gallons) (2 days) = 6 gallons
L
Z
2
(3.5) 1.871
7
ROP
86
1.069
L
1.871
Z is approximately 1.07. From Appendix B, Table B, the lead time service level is .8577. Risk of
stockout is 1 - .8577 = .1423
13-20
c. 1 day after From a, ROP = 8.39

2 more days
on hand = ROP 2 gal. = 6.39
P (stockout)= ?
d = 21 gal./wk.
d = 3.5 gal./wk.
22.
23.
24.
d
ROP
LT
ss
Risk
6.39 = 21 (2/7) + Z
solving, Z
2/7
(3.5)
6.39 6
.208 .21
1.871
From Appendix B, Table B, Z=.21 gives a risk of

1 .5832 = .4168 or about 42%
= 30 gal./day
= 170 gal.
ss = ZdLT = 50
= 4 days
= 50 gal.
= 9%
Z = 1.34 Solving, dLT = 37.31
3% Z = 1.88 x 37.31 = 70.14 gal.
D = 85 boards/day
ROP = 625 boards
LT = 6 days
LT = 1.1 day
SL 96% Z = 1.75
d
= 12 units/day LT = 4 days
= 2 units/day LT = 1 day
ROP = d x LT + Z d LT
625 = 85 x 6 + Z (85) 1.1
Z = 1.23 10.93%
.1093 approx. 11%
2
ROP = dLT + Z LT d 2 d LT 2
= 12 (4) + 1.75 4( 4) 144(1)
= 48 + 1.75 (12.65)
= 48 + 22.14
= 70.14
13-21
25.
LT = 3 days
S = $30
D = 4,500 gal
H = $3
360 days/yr.
4 ,500
d
12.5 / day
360
d = 2 gal.
Risk = 1.5% Z = 2.17
a.
Qty.
Unit Price
1 399
$2.00
400 799
1.70
800+
1.62
Qo =
2DS
300
H
TC = Q/2 H + D/Q S + PD
TC300 = 150 (3) + 15 (30) + 2(4,500) = $9,900
TC400 = 200(3) + 11.25(30) + 1.70(4,500) = $8,587.50*
TC800 = 400(3) + 5.625(30) + 1.62(4,500) = $8,658.75
b. ROP = d LT + Z LT d
= 12.5 (3) + 2.17 3 (2)
= 37.5 + 7.517
= 45.02 gal.
26.
d
d
LT
S
H
a.
= 5 boxes/wk.
= .5 boxes/wk.
= 2 wk.
= $2
= $.20/box
D = .5 boxes/wk. x 52 wk./yr. = 26 boxes/yr.
2DS
2( 260) 2
Q0
72.11 round to 72
H
.20
b. ROP = d (LT) + z LT (d)
z
ROP d ( LT )
LT ( d )
12 5( 2)
2 (.5)
2.83
Area under curve to left is .9977, so risk = 1.0000 .9977 = .0023

c.
Q 0 d (OI LT ) z d OI LT A
Thus,
36 = 5(7 + 2) + z(.5) 7 2 12
Solving for z yields z = +2.00 which implies a risk of 1.000 .9772 = .0228.
13-22
27.
d = 80 lb.
d = 10 lb.
LT = 8 days
LT = 1 day
SL = 90 percent, so z = +1.28
a. ROP = d (() + z
LT 2 d d 2 LT
= 80 (8) + 1.28 8(10) 2 80 2 (1) 2 = 640 + 1.28 (84.85)

= 748.61 [round to 749]
b. E(n) = E(z) dLT = .048(84.85) = 4.073 units
28.
D = 10 rolls/day x 360 days/yr. = 3,600 rolls/yr.

d = 10 rolls/day
LT = 3 days
H = $.40/roll per yr.
d = 2 rolls/day
S = $1
a.
2 DS
2(3, 600)1
Q0
134.16 [round to 134]
.40
b. SL of 96 percent requires z = +1.75

ROP = d (LT) + z LT (d) = 10(3) + 1.75 (3) (2) = 36.06 [round to 36]
c. E(n) = E(z) dLT = .016( LT )(d) = .016 3 (2) = .055/cycle
D
3600
E(N) = E(n)
= .0554
= 1.488 or about 1.5 rolls
Q
134
3.464
dLT
d. 1 SLannual E ( z ) Q (.016) 134.16 .000413
SLannual 1 .000413 .9996
13-23
29.
(Partial Solution)
SLannual = 99%
a. SS = ?
b.
Qo = 179 cases
E(z) dLT
Q
E(z) dLT
.99 = 1
179
Solving, E(z) = 0.358
From Table 123, Z = 0.08
Hence, the probability of a stockout
is 1-.8577=.1423.
SLannual = 1
risk = ?
dLT = 80, dLT = 5
a. ss = ZdLT
= .08 (5) = .40 cases
b. 1 .5319 = .4681
30.
d = 250 gal./wk. H = $1/month

d = 14 gal./wk. S = $20
LT = 10 wk.
.5 Yes
SLannual = 98%
a.
SLannual = 1 (z) dLT

Q
dLT = LT d
= 5 (14)
= 9.90
FOI
SL = .98
OI = 14 days
Q0
.02 =
2DS 2(13,000) 20
208.16 208
H
12
(z) 9.90
208
E(z) = .42 z = .04
SL = .4840
b. E(n) = E(z) dLT

5 = E(z)9.90
E(z) = .505 z = .20
SL = .4207
31.
D = 250 gal./wk. x 52 wk./yr. = 13,000 gal./yr.
SS = .04(9.90) = .40
SS = zdLT
SS = .20(9.90) = 1.98 units
Q = d (OI + LT) + zd OT LT A
= d (16) + 2.05d 16 A
Cycle
1
640 + 2.05(3) 16 42 = 622.6 623 units
LT = 2 days
640 + 2.05(3)
16
8 = 656.6 657 units
D = 40/day
640 + 2.05(3)
16
103 = 561.6 562 units
d = 40/day
2 = 3/day
13-24
32.
50 wk./yr.
P34
D = 3,000 units
P35
D = 3,500 units
d = 60 units/wk.
d
LT
unit
cost
H
S
Risk
d = 70 units/wk.
= 4 units/wk.
= 2 wk.
= $15
= (.30)(15) = $4.50
= $70
= 2.5%
d
LT
unit
cost
H
S
Risk
= 5 units/wk.
= 2 wk.
= $20
= (.30)(20) = 6.00
= $30
= 2.5%
Q = (OI + LT) d + z
2(3,000)70
305.5 306 units
4.50
ROPP34 = d x LT+ z LT d
Q P 34
QP35 = 70 (4 + 2) + 1.96
LT d A
4 2 (5) 110
QP35 = 420 + 24 110

QP35 = 334 units
ROPP34 = 60(2) + 1.96 2 (4) = 131.1

33.
a.
Item
H4-010
H5201
P6-400
P6-401
P7-100
P9-103
TS-300
TS-400
TS-041
V1-001
Annual $ volume
50,000
240,800
279,300
174,000
56,250
165,000
945,000
1,800,000
16,000
132,400
Classification
C
B
B
B
C
C
A
A
C
C
Item
H4-010
H5-201
P6-400
P6-401
P7-100
P9-103
TS-300
TS-400
TS-041
V1-001
Estimated annual
demand
20,000
60,200
9,800
14,500
6,250
7,500
21,000
45,000
800
33,100
Ordering cost
50
60
80
50
50
50
40
40
40
25
b.
13-25
Unit holding cost

($)
.50
.80
8.55
3.60
2.70
8.80
11.25
10.00
5.00
1.40
EOQ
2,000
3,005
428
635
481
292
386
600
113
1,087
34.
Cs = Rev Cost = $4.80 $3.20 = $1.60

Ce = Cost Salvage = $3.20 $2.40 = $.80
Cs
$1.60
1.6
SL =
=
=
= .67
Cs + Ce
$1.60 + $.80
2.4
Since this falls between the cumulative
probabilities of .63(x = 24) and .73(x = 25),
this means Don should stock 25 dozen doughnuts.
35.
Cs = $88,000
Ce = $100 + 1.45($100) = $245
Cs
$88,000
a. SL =
=
= .9972
Cs + Ce
$88,000 + $245
Using the Poisson probabilities, the minimum level
stocking level that will provide the desired service
is nine spares (cumulative probability = .998).
13-26
.4545
.11 0
78.9 80
x
Demand
19
20
21
22
23
24
25
26
27
.
.
.
z-scale
doz. doughnuts
P(x)
.01
.05
.12
.18
.13
.14
.10
.11
.10
.
.
.
Cum.
P(x)
.01
.06
.18
.36
.49
.63
.73
.84
.94
.
.
.
[From Poisson Table with = 3.2]

x
Cum. Prob.
0
.041
1
.171
2
.380
3
.603
4
.781
5
.895
6
.955
7
.983
8
.994
9
.998
.
.
.
.
.
.
b.
SL
Cs
Cs Ce
.041
Cs
C s 245
.041(C s 245) C s
.041C s 10.045 C s
.959C s 10.045
C s $10.47
Carrying no spare parts is the best strategy if the shortage cost is less than or equal to $10.47 (
C s 10.47 ).
36.
37.
Cs = Rev Cost = $5.70 $4.20 = $1.50/unit

Ce = Cost Salvage = $4.20 $2.40 = $1.80/unit
$1.50
Cs
$1.50
SL =
=
=
= .4545
$3.30
Cs + Ce
$1.50 + $1.80
The corresponding z = .11
So = d z d = 80 .11(10) = 78.9 lb.
d = 80 lb./day
d = 10 lb./day
d = 40 qt./day A stocking level of 49 quarts translates into a z of + 1.5:
d = 6 qt./day
S
Ce = $.35/qt
Cs = ?
S = 49 qt.
= 49 40 = 1.5
d
6
This implies a service level of .9332:
z=
.9332
0
1.5
z-scale
40
49
quarts
Cs
Cs
Thus, .9332 =
Cs + Ce
Cs + $.35
Solving for Cs we find: .9332(Cs + .35) = Cs; Cs = $4.89/qt.
SL =
Customers may buy other items along with the strawberries (ice cream, whipped cream, etc.) that
they wouldnt buy without the berries.
13-27
38.
Cs = Rev Cost = $12 $9 = $3.00/cake

Ce = Cost Salvage = $9 ($9.00) = $4.50/cake
Demand is Poisson with mean of 6
Cs
$3.00
SL =
=
= .40
Cs + Ce
$3.00 + $4.50
Since .40 falls between the cumulative
probability for demand of 4 and 5, the
optimum stocking level is 5 cakes.
39.
40.
[From Poisson Table with = 6.0]

Demand Cum. Prob.
0
.003
1
.017
2
.062
3
.151
4
.285
.40
5
.446
6
.606
.
.
.
.
.
.
Cs = $.10/burger x 4 burgers/lb. = $.40/lb.

Ce = Cost Salvage = $1.00 $.80 = $.20/lb.
Cs
$.40
SL =
=
= .6667.
Cs + Ce
$.40 + $.20
The appropriate z is +.43.
So = + z = 400 + .43(50) = 421.5 lb.
Cs = $10/machine
Ce = ?
S = 4 machines
.6667
Demand Freq.
0
.30
1
.20
2
.20
3
.15
4
.10
5
.05
1.00
0 .43
z-scale
400 421.5
lb.
Cum.
Freq.
.30
.50
.70
.85
.95
1.00
$10
.95.
$10 + Ce
Setting the ratio equal to .85 and solving for Ce yields $1.76, which is the upper end of the range.
Setting the ratio equal to .95 and again solving for Ce , we find Ce = $.53, which is the lower end of
the range.
b. The number of machines should be decreased: the higher excess costs are, the lower SL becomes,
and hence, the lower the optimum stocking level.
c. For four machines to be optimal, the SL ratio must be between .85 and .95, as in part a. Setting the
ratio equal to .85 yields the lower limit:
Cs
.85 =
Solving for Cs we find Cs = $56.67.
Cs + $10
Setting the ratio equal to .95 yields the upper end of the range:
Cs
.95 =
Solving for Cs we find Cs = $190.00
Cs + $10
a. For four machines to be optimal, the SL ratio must be .85
13-28
41.
a.
Ratio Method
# of spares
Probability of Demand
0
0.10
1
0.50
2
0.25
3
0.15
Cumulative Probability
0.10
0.60
0.85
1.00
Cs = Cost of stockout = ($500 per day) (2 days) = $1000

Ce = Cost of excess inventory = Unit cost Salvage Value = $200 $50 = $150
SL
Cs
1,000
.869
C s C e 1,000 150
Since 86.9% is between cumulative probabilities of 85% and 100%, we need to order 3 spares.
b.
Stocking
Level
0
1
2
3
Tabular Method
Demand = 0
Prob. = 0.10
$0
.10(1)($150)=$15
.10(2)($150)=$30
.10(3)($150)=$45
Demand = 1
Prob. = 0.50
.50(1)($1000)=$500
$0
.50(1)($150)=$75
.50(2)($150)=$150
Demand = 2
Prob. = 0.25
.25(2)($1000)=$500
.25(1)($1000)=$250
$0
.25(1)($150)=$37.50
We should order 3 spares.
13-29
Demand = 3
Prob. = 0.15
.15(3)($1000)=$450
.15(2)($1000)=$300
.15(1)($1000)=$150
$0
Expected
Cost
$1,450
$565
$255
$232.50
42.
a. Ratio Method: Demand and the probabilities for the cases of wedding cakes are given in the
following table.
Demand
0
1
2
3
Probability of Demand
0.15
0.35
0.30
0.20
Cumulative Probability
0.15
0.50
0.80
1.00
Cs = Cost of stockout = Selling Price Unit Cost = $60 $33 = $27

Ce = Cost of excess inventory = Unit Cost Salvage Value = $33 $10 = $23
SL
Cs
27
.54
Cs Ce 27 23
Since the service level of 54% falls between cumulative probabilities of 50% and 80%, the
supermarket should stock 2 cases of wedding cakes.
b. Tabular Method
Stocking
Level
0
1
2
3
Demand = 0
Prob. = 0.15
$0
.15(1)($23)=$3.45
.15(2)($23)=$6.90
.15(3)($23)=$10.35
Demand = 1
Prob. = 0.35
.35(1)($27)=$9.45
$0
.35(1)($23)=$8.05
.35(2)($23)=$16.10
Demand = 2
Prob. = 0.30
.30(2)($27)=$16.20
.30(1)($27)=$8.10
$0
.30(1)($23)=$6.90
The supermarket should stock 2 cases of wedding cakes.
43.
Cs = $99, Ce = $200
SL =
99___
99 + 200
= 0.3311.
z = 0.44.
Overbook: 18 0.44(4.55) = 15.998, or 16 tickets.

44.
Mean usage = 4.6 units/day

Standard dev. = 1.265 units/day
LT = 3 days
ROP = 18
Using equation 12-13: 18 = 4.6(3) + z(1.265)3
Solving, z = 1.92 which gives a service level of 97.26%.
13-30
Demand = 3
Prob. = 0.20
.20(3)($27)=$16.20
.20(2)($27)=$10.80
.20(1)($27)=$5.40
$0
Expected
Cost
$41.85
$22.35
$20.35
$33.35
Case: UPD Manufacturing

1 Students must recognize that without demand variability, the fixed order interval order quantity
equation reduces to:
Q = d(LT + OI) Available (because there is no safety stock)
Since Available = d x LT, the fixed order interval order quantity equation Q further reduces to the
following:
Q = d x OI = (6) (89) = 534 units
Therefore, ordering at six-week intervals requires an order quantity of 534 units.
On the other hand, the optimal order quantity is determined by using the basic EOQ equation.
Q
2dS
2(89)(32)
267
.08
The weekly total cost based on optimal order quantity EOQ is given below:
d
Q
89
267
S
TC EOQ
H
32
.08
Q
2
267
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
S
TC FOI
H
32
.08
Q
2
534
TC FOI 5.33 21.36 26.69 / week
Weekly savings of using EOQ rather than 6-week FOI is 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 six-week FOI to EOQ are relatively small and
switching to the optimal order quantity may not be warranted. However, even though the absolute value
of the savings is relatively small, the percentage of savings is approximately 25% (5.34 / 21.35).
Therefore if FOI approach is used with other parts or components as well, the total potential loss may be
significant.
13-31
Case: Harvey Industries

In order to improve the current inventory control system, the new president may want to consider the
following:
1. Computerize the inventory control system. There are too many parts for the current manual
system.
2. Currently, no paper work 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. As a result of these
actions, the inventory accuracy should substantially improve.
3. It appears that utilization of ABC inventory classification system is needed. The company should
never experience stockouts in their basic C items. 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

The presidents 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.
The main problem is inventory management. One advantage of having a single, centralized warehouse is
the lower need for safety stock due to the canceling effect of random variability in orders from the various
regions. Conversely, with separate warehouses, each warehouse needs a relatively larger safety stock to
guard against variations in demand. What is needed is overall control of the system that would take into
account seasonal variations in demand and achieve a better match between regional demand and supply.
This might involve making or improving regional forecasts. In any case, improved system visibility is
essential: direct access to regional warehouse data by the main warehouse is needed in order to be able to
coordinate and set priorities on inventory shipments to regional warehouses. That should take care of
most of the problem. It may also pay to examine the feasibility of shipping from one warehouse to
another when a shortage occurs. Relevant costs would include transaction costs, transportation costs,
versus the potential increase in profit by making up a shortage.
13-32
Case: Farmers Restaurant

1. Inventories are crucial not only to Farmers Restaurant, but to businesses in general. Customer
satisfaction and customer return is contingent upon proper inventory management. If customers visit the
Farmers Restaurant and are unable to receive the food they desire due to stockout, the customer may be
dissatisfied and may not return to Farmers Restaurant. In addition to customer satisfaction, total food
costs are also important to businesses. In the restaurant industry if too much of a product is ordered and
not used; it could result in product wastage due to the items expiring. This would result in an increase in
total food costs when the goal is to keep food costs low! Overstocking products can also negatively affect
Farmers Restaurant and other businesses. By having more products on-hand than needed, Farmers
Restaurant is tying up funds that might be more productive elsewhere. Overall, it is imperative that
Farmers Restaurant try to successfully manage inventory levels due to these potential/existing problems.
2. A fixed-interval ordering system is appropriate.
3. Q = d (OI + LT) + zd (OI + LT) A
OI = Time between orders
LT = Lead Time
It is expected demand between orders and lead time + safety stock inventory on hand
Q = 5 (3+2) + 1.64 (3.5) (3 + 2) 3
= 25 + 13 3
= 35 (Therefore, 18 2-packs.)
4. 12 = 5 x 2 + z (3.5) (1.41)
12 = 10 + z (4.935)
2 / 4.935 = z (4.935) / 4.935
Z = 0.41
Service Level = 0.6554
1 0.6554 = 0.3446
Therefore, the risk for stockout is 34.46% which is high
13-33
Operations Tour: Brueggers Bagel Bakery

1.
If too little inventory is maintained, there is a risk of stockout and potential lost sales. In
addition, if there is not sufficient work-in-process inventory, the production process may become
too inefficient, raising the cost of production. On the other hand, if too much inventory is
maintained, the carrying cost may become excessively high.
2.
a. Customers judge the quality of bagels by their appearance (size, shape and shine), taste
and consistency. Customers are also very interested in receiving high service quality.
b. At each stage of the production process, workers check bagel quantity.
c. Steps for Brueggers Bagel Bakery Operations:
a. Purchase ingredients from suppliers
b. Mix the dough
c. Shape the dough
d. Ship to stores
e. Store the bagels
f.
Boil and malt
g. Bake
h. Sell to customers
The company can improve quality at each step by monitoring output more carefully and training
and education of the employees.
3.
The basic ingredients can be purchased using either fixed order interval or fixed order
quantity models. EOQ production lot size model is most appropriate for deciding the size of
production quantity.
4.
If there is a bagel-making machine at each store, the company would have to invest in
more machinery, more space for production and storage, and more worker training for the
production of bagels. However, the lead time to make the bagels will be shortened. The shorter
lead time will provide faster, more flexible response to customer demands and fresher bagels.
Enrichment Module: Advanced EOQ Problem

This enrichment module consists of an additional EOQ problem to further solidify the concepts associated
with the Economic Production Model. The question forces the students to work backwards through the
EOQ production equation.
Problem
A company produces plastic powder in lots of 2000 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.
13-34
a.
b.
What weekly holding cost per pound does the lot size imply, assuming the lot size is optimal?
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 d 50 lbs. / hr.
S $100
D (50 lbs. / hr .) x (8 hrs. / day ) x (5 days / week ) 2,000 lbs. / week
Q
2 DS
x
H
2,000
2( 2,000)(100)
250
H
250 50
2,000
400,000
x(1.25)
H
2,000
500,000
H
( 2,000) 2
H
b.
p
pd
500,000
H
500,000
$.125 / week
4,000,000
Decreasing the value of carrying cost (H) will result in an increase in the lot size. Since
holding inventory is not as expensive, the firm can afford to carry more inventory and
therefore produce a larger batch.
13-35
Enrichment Module 2: Inventory Model with Planned Shortages

In most cases, shortages are undesirable and should be avoided. However, in certain circumstances, it may
be desirable to plan and allow for shortages. Planned shortages are implemented for high dollar volume
items where the inventory carrying cost is very high. The model discussed in this section refers to the
specific type of shortages called backorders. When a customer attempts to purchase an out-of-stock item,
the firm does not lose the sale. The customer waits until the purchased order arrives from the supplier. If
there were no additional cost associated with backordering, there would be no incentive for the firm to
maintain any inventory. However, there are costs associated with backordering. The tangible part of the
backorder cost involves the cost of expediting the delivery (special delivery) and production of the
backordered item. The intangible part of the backordering cost involves the loss of goodwill due to the
fact that the customers are forced to wait for their orders. The longer the waiting period, the higher the
backorder cost due to loss of goodwill.
There is a direct trade-off between the inventory carrying cost and the cost of a planned shortage in the
form of backorders. In many cases the cost of backorders can be easily offset by the reduction in carrying
costs. The model discussed in this section will not be valid if a customer decides not to wait for the
backorder.
The fixed order quantity inventory model with planned shortages (backorders) is very similar to the basic
EOQ model. When the reorder point is reached, a new economic order quantity (Q) is placed. Figure 1
shows the schematic representation of this model. The size of the backorder is B units and the maximum
inventory is QB units. The average size of the backorder is B/2 for each order cycle. T is defined as the
amount of time between two successive orders (a complete order cycle). t 1 is the part of the order cycle
where the customer orders are met from stock. In other words, during t 1 there is positive inventory level.
On the other hand, t2 is the period of time in the order cycle where the inventory is depleted and all the
customer orders are placed on backorder (stockout period).
Symbol definitions used to explain various concepts are listed below.
H = carrying cost per unit per year
S = setup cost per batch (lot)
D = annual demand
Q* = optimal order quantity
B = size of the backorder
CB = backorder cost per unit per year
B* = optimal planned backorder quantity
T = Q/D (length of the complete order cycle in years) or
T = Q/d (length of the complete order cycle in days)
t1 = (Q B)/D or (Q B)/d (time period during which inventory is positive)
t2 = B/D or B/d (time period during which there is no inventory)
In this model, the average inventory is not Q/2 or not even (Q B)/2 because during the shortage period
there are no units in inventory. The average inventory calculation for this model can be explained with the
following example:
13-36
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 7500 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 t 1 and no units during t2. Therefore, total
number of unit days during the inventory cycle can be computed by multiplying t 1 with (Q B)/2
Number of unit days of inventory/cycle t1 *
Number of unit days of inventory/cycle
QB
2
(Q B) (Q B )
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.
Since 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
2d
Average inventory
Q
d
Average Inventory
(Q - B)2
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. Since 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:
13-37
B2
Average backorder 2d
Q
d
Average backorder
B2
2Q
Annual inventory carrying cost is still calculated by multiplying the average inventory with the inventory
carrying cost per unit per year. The formula for the annual ordering (setup) cost is the same as it was for
the basic EOQ model. The annual backorder cost is determined by multiplying the average backorder
quantity with 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, annual ordering cost and the annual backordering cost as shown in the following formula:
TC
(Q B) 2
D
B2
H S
CB
2Q
Q
2Q
Taking the first total derivative of the above total cost formula with respect to Q and 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:
Q*
2 DS H C B
H
CB
H B
B* Q *
13-38
Figure 1
An inventory situation with planned shortages
Inventory
Maximum Inventory Level
QB
t1
Stockout B
QB
Time
t2
T = Q/d
Example:
XYZ Company distributes a major part for the F15 fighter jets. Due to the very high holding cost, the
company wants to implement a model with planned shortages. The annual demand is 78,000 and the
company operates 300 days per year. The annual carrying rate is 10% of the item cost and the unit cost of
this item is $1,000. The setup cost per batch is estimated at $500.
a.
Determine the optimal order quantity and total annual inventory cost (setup 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 setup 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
a.
Q*
2DS
H
2(81,000)(500)
900
100
Q*
D
81,000
(500) 45,000
900
S
annual setup cost =
Q
900
( H)
(100) 45,000
2
2
annual carrying cost =
13-39
Q*
2DS (H C B )
H
CB
Q*
2(81,000)(500) 100 200
H
200
Q*
3
81,000
Q * 1,215,000 1,102.3
H
B Q *
H
CB
100
B (1,102.3)
367.433
100 200
c.
(Q B) 2
H
2Q
Annual carrying cost
(1,102.3 367.43) 2
(100)
2(1,102.3)
24,495.77
D
81,000
(S) 1,102.3 (500)
Q
Annual setup cost
36,741.35
B2
C B
Annual backorder cost
2Q
367.4332
( 200) 12,247.55
2(1,102.3)
Let TC = Total annual inventory cost

HC = annual inventory holding cost
SC = annual setup cost
BC = annual backordering cost
TC = HC + SC + BC = 24,495.77 + 36,741.35 + 12,247.55 = 73,485.07
13-40
d.
e.
81,000
27
300
Q 1,102.3
40.83 days
d
27
t1
Q B 1,102.3 367.43
27.22 days
d
27
t2
B * 367.43
13.61 days
d
27
The model with planned backorders is preferred because the total annual inventory cost of the
basic inventory model is substantially higher than the total annual inventory cost of the planned
backorder model.
TCbasic EOQ = 90,000
TCbackorder = 73,485.07
90,000 73,485.07 = 16,514.93
The total cost savings equal 18.4%
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 managements
continued pressure for cost reduction, you have been asked to analyze the economics of a backordering
policy for some products that can possibly be backordered. For a specific product with D = 800 units per
year, C0 =$150, H = $10, and Cb = $20, what is the economic 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
C0 = $150
H = $10/unit/year
Cb = $20/unit/year
Planned shortage model:
13-41
Q*
2DS ( H C B
H
CB
Q*
92,000 189.737 units
H
H
CB
B* Q *
2( 800 )( 150 ) ( 10 ) 20
10
20
10
( 189.737 )
63.24 units
30
EOQ model:
2DS
Q*
2(800)(150)
154.92 units
10
Total cost planned shortage model:

TC = Total annual inventory cost
HC = Annual inventory holding cost
SC = Annual setup cost
BC = Annual backordering cost
(Q B) 2
(189.737 63.24) 2
H
(10) $421.68
2Q
2(189.737)
HC =
800
S
(150) $632.45
SC =
189.737
Q
B2
(63.24) 2
BC =
B 2(189.737) 20 $210.78
2Q
TC = HC + SC + BC = 421.68 + 632.45 + 210.78

TC = $1,264.91
Total cost regular EOQ model:
Q
154.92
H
(10) $774.60
2
2
HC =
800
S
(150) $774.60
SC =
154.92
Q
TC = HC + SC = 774.60 + 774.60 =$1,549.20

TCDifference = 1,549.20 1,264.91 = $284.29
Using the planned shortage model will result in savings of $284.29.
Number of orders =
D
800
4.216 orders
Q 189.737
13-42
Expected annual number of units short = (B)

Q
Expected annual number of units short = (63.24)(4.216) = 266.44

d=
D
800
3.2 units/day
250 250
t2 =
63.24
19.763 days
3.2
Since 19.763 < 20 and
266.44
< .35, the backorder inventory policy should be adopted.
800
13-43

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Chapter 13 - Inventory Management

Answers to Discussion and Review Questions

Chapter 13 - Inventory Management

a. Only one product is involved.

b. Annual demand requirements are known.

Chapter 13 - Inventory Management

A company can reduce the need for inventories by:

g. reducing production lead time by using more efficient manufacturing methods

a. If we buy additional amounts of a particular good to take advantage of quantity discounts,

Chapter 13 - Inventory Management

Critical Thinking Exercise

Chapter 13 - Inventory Management

Can he purchase forever stamps and temporarily avoid a price increase?

Student answers will vary.

Memo Writing Exercises

Cost of carrying inventory must be weighted against the following costs:

cost of quantity discounts

g. cost of smoothing production for seasonal products.

The possible advantages of using a single supplier include:

Chapter 13 - Inventory Management

Usage x Unit Cost

Percent of Total Cost

Chapter 13 - Inventory Management

b. Q/2 = 18/2 = 9 bags

Chapter 13 - Inventory Management

e. Assuming that holding cost per bag increases by $9/bag/year

Increase by [$1,428.71 $1,350] = $78.71

D = 40/day x 260 days/yr. = 10,400 packages

TC200 = 3,000 + 3,120 = $6,120

Chapter 13 - Inventory Management

D = 750 pots/mo. x 12 mo./yr. = 9,000 pots/yr.

TC = 450 + 120 = $570

Only about one half of the storage space would be needed.

u = 800/month, so D = 12(800) = 9,600 crates/yr.

Chapter 13 - Inventory Management

b. The EOQ model requires this.

Chapter 13 - Inventory Management

Chapter 13 - Inventory Management

D= 250/day x 300 days/yr. = 75,000 hotdogs/yr.

300 days per year

b. D/Qo = 75,000/4,812 = 15.59, or about 16 runs/yr.

D= 20 tons/day x 200 days/yr. = 4,000 tons/yr.

d. Runs per year:

Savings would be $774.50

Chapter 13 - Inventory Management

Q0 = (1,095.451) (1.2910) = 1,414 units

c. 200 80 = 120 units per day

848 80/day = 10.6 days

Chapter 13 - Inventory Management

p = 800 units per day

d. Production time per batch =

Setup time per batch = day

Chapter 13 - Inventory Management

Hence, the best order quantity would be 5,000 boxes.

3.6 orders per year

Chapter 13 - Inventory Management

( Not feasible at $8/stone)

Chapter 13 - Inventory Management

Compare TC495 with TC for all lower price breaks:

495 497 500 503

Chapter 13 - Inventory Management

D = (800) x (12) = 9600 units

813.88 813.87 132 ,480