Chapter 3

Continuous Probability Distributions

Chapter 3
Continuous Probability Distributions
Case Problem: Specialty Toys

1.

Information provided by the forecaster

.
025

.
95

10,000

20,000

At x = 30,000,
z=

x 30, 000 20, 000

=
= 1.96

30, 000 20, 000

= 5102
1.96

Normal distribution = 20, 000

2.

= 5102

@ 15,000
z=

15, 000 20, 000

= 0.98
5102

P(stockout) = 0.3365 + 0.5000 = 0.8365

@ 18,000
z=

18, 000 20, 000

= 0.39
5102

P(stockout) = 0.1517 + 0.5000 = 0.6517

@ 24,000

CP - 18

.
025
30,000

Chapter 3

Continuous Probability Distributions

z=

24, 000 20, 000

= 0.78
5102

P(stockout) = 0.5000 - 0.2823 = 0.2177

@ 28,000
z=

28,000 20, 000

= 1.57
5102

P(stockout) = 0.5000 - 0.4418 = 0.0582

3.

Profit projections for the order quantities under the 3 scenarios are computed below:
Order Quantity: 15,000
Sales
Unit Sales
10,000
20,000
30,000

Total Cost
240,000
240,000
240,000

at $24
240,000
360,000
360,000

at $5
25,000
0
0

Profit
25,000
120,000
120,000

Order Quantity: 18,000

Sales
Unit Sales
10,000
20,000
30,000

Total Cost
288,000
288,000
288,000

at $24
240,000
432,000
432,000

at $5
40,000
0
0

Profit
-8,000
144,000
144,000

Order Quantity: 24,000

Sales
Unit Sales
10,000
20,000
30,000

Total Cost
384,000
384,000
384,000

at $24
240,000
480,000
576,000

at $5
70,000
20,000
0

Profit
-74,000
116,000
192,000

Order Quantity: 28,000

Sales
Unit Sales
10,000

Total Cost
448,000

at $24
240,000

at $5
90,000

CP - 19

Profit
-118,000

Chapter 3

Continuous Probability Distributions

20,000
30,000

4.

448,000
448,000

480,000
672,000

40,000
0

72,000
224,000

We need to find an order quantity that cuts off an area of .70 in the lower tail of the normal curve for
demand.

30%
70%

20,000 Q
z = 0.52

Q 20, 000
z=
= 0.52
5102
Q = 20,000 + 0.52(5102) = 22,653

The projected profits under the 3 scenarios are computed below.

Order Quantity: 22,653
Sales
Unit Sales
10,000
20,000
30,000

Total Cost
362,488
362,488
362,488

at $24
240,000
480,000
543,672

at $5
63,265
13,265
0

CP - 20

Profit
-59,183
130,817
181,224

Chapter 3

5.

Continuous Probability Distributions

A variety of recommendations are possible. The students should justify their recommendation by
showing the projected profit obtained under the 3 scenarios used in parts 3 and 4. An order quantity
in the 18,000 to 20,000 range strikes a good compromise between the risk of a loss and generating
good profits.
While the students don't have the benefit of the following, a single-period inventory model
(sometimes called the news vendor model) shows how to find an optimal solution. We outline that
solution below.
A single-period inventory model recommends an order quantity that maximizes expected profit
based on the following formula:
P(Demand Q* ) =

cu
cu + co

*
where P(Demand Q ) is the probability that demand is less than or equal to the recommended
*
order quantity, Q . cu is the cost of underestimating demand (having lost sales because of a stockout)
and co is the cost per unit of overestimating demand (having unsold inventory). Specialty will sell
Weather Teddy for $24 per unit. The cost is $16 per unit. So, cu = $24 - $16 = $8. If inventory
remains after the holiday season, Specialty will sell all surplus inventory for $5 a unit. So, co = $16 -

$5 = $11.
P(Demand Q* ) =

8
= 0.4211
8 + 11

0.4211

0.5789
Q*
z = -0.20

z=

Q* 20, 000
= 0.20
5102

Q* = 20, 000 0.20(5102) = 18,980

The profit projections for this order quantity are computed below:
Order Quantity: 18,980
Sales
Unit Sales

Total Cost

at $24

at $5

CP - 21

Profit

Chapter 3

Continuous Probability Distributions

10,000
20,000
30,000

303,680
303,680
303,680

240,000
455,520
455,520

44,900
0
0

CP - 22

-18,780
151,840
151,840