6
C H A P T E R
Inventory Control Models
TEACHING SUGGESTIONS
Teaching Suggestion 6.1: Importance of Inventory Control.
Inventory control is important to most organizations. This chapter
on inventory control can be introduced to students by a discussion
of the consequences of too much and not enough inventory. The
high cost of carrying too much inventory and the problems of
stockouts, lost customers, and reduced market share as a result of
too little inventory can be introduced at the beginning of this chap-
ter. You may want to use a car dealership example. Should the car
dealership stock every model and color? How many types of cars
should be stocked?
Teaching Suggestion 6.2: Examples of the Functions of
Inventory Control.
The importance of inventory to store resources, take advantage of
quantity discounts, and avoid stockouts is discussed in this chap-
ter. Students can be asked to give examples of how each of these
important functions has been or can be used by organizations. An
in-class discussion will help students realize the relevance of in-
ventory control.
Teaching Suggestion 6.3: Importance of Basic
Inventory Assumptions.
The assumptions of the basic EOQ model are important. The sim-
ple EOQ formula is a direct result of these assumptions. Students
can be told that these assumptions will be relaxed in more com-
plex models and inventory procedures.
Teaching Suggestion 6.4: Setting Ordering Cost Equal to
Carrying Cost Doesn’t Always Work for More Complex Models.
This chapter determines the formula for the basic economic order
quantity by setting ordering cost equal to carrying cost. Some stu-
dents might get the wrong idea that this approach can be used with
all inventory problems. Students should be told that calculus pro-
cedures can be used to determine the basic EOQ formulas and are
needed for more complex inventory situations.
Teaching Suggestion 6.5: Other Ways of Looking at
Inventory Problems.
In this chapter, students are shown how to compute the optimal
number of orders per year and the number of days between orders.
70
This was done so students can see that there are different ways to
look at the same inventory problem. This is a good place to point
out that there are many ways of solving the same problem. The
problems at the end of the chapter ask students to compute related
inventory quantities, including the optimal number of orders per
month and the optimal number of weeks between orders.
Teaching Suggestion 6.6: Comparing the Basic EOQ Model with
the EOQ Model without the Instantaneous Receipt Assumption.
This chapter computes EOQ for the case where the instantaneous
receipt assumption is relaxed. A comparison of the traditional
EOQ model and this model can be made. The major difference is
the holding cost, which is reduced compared to the traditional
EOQ formula. This is due to the change in the average inventory
level for this model.
For example, if demand is 50% of production, then the aver-
age inventory level will be 50% of what it would be otherwise.
This also means that annual holding costs will be 50% lower. Like
other inventory formulas, this one makes sense intuitively.
Teaching Suggestion 6.7: Adjusting the Order Quantity Upward.
The quantity discount model is not difficult to apply. The major
problem students have is that they forget to adjust the order quan-
tity upward if the quantity is too low to qualify for the discount.
This is step 2 of the quantity discount approach. If this is not done,
the results will likely be incorrect. You may have to reinforce the
material in the book to make sure students don’t make this mis-
take.
Teaching Suggestion 6.8: Stockout Cost Calculations May Be
Difficult to Understand for Some.
The safety stock calculations with known stockout costs is
straightforward. The only area that students may have problems
with is the computation of stockout costs. When the safety stock is
low, there is a greater possibility of a stockout. In general, stock-
out costs are the number of units short (short) times the probability
(P) times the stockout cost (cost) times the number of orders per
year (orders).
Teaching Suggestion 6.9: High Cost of a High Service Level.
The computations for stockout policy without stockout costs are
easy to understand. The analysis assumes that demand follows a
 CHAPTER 6 INVENTORY CONTROL MODELS 71

normal distribution. Students should be told that the same type of year. The following equation can be used to compute the eco-
analysis can be made with other probability distributions. It is nomic order quantity.
even possible to perform this type of analysis with an observed
discrete probability distribution.
It should be noted that the cost of this type of inventory pol-
Q*  2(20,000)(100)
5
 894
icy increases dramatically with an increase in service level. This is Alternative Example 6.2: Paul Peterson is considering manu-
shown in Figure 6.10. The relationship between service level and facturing hole-punch devices. As in Alternative Example 6.1, the
total cost should be emphasized. As service level increases, the in- annual demand is 20,000 units. The setup cost is $100 per order,
ventory costs increase exponentially. Discuss the ethical issues of and the carrying cost is $5 per unit per year. The demand rate is
setting service levels of emergency plasma or drug supplies in a 100 units per day and the production rate is 150 units per day. The
hospital. following equation can be used to determine the economic lot size.
Teaching Suggestion 6.10: Use of ABC Analysis.
ABC analysis is a very practical and useful concept. Although the
mathematics is straightforward and easy to understand, these tech-
Q* 
5(12(20,000)(100)
 100/150)
 1,549

niques can result in substantial savings. Students can be told that
sophisticated and complex analysis does not always result in great
savings. Some simple and easy-to-implement policies can be the
most effective.
Teaching Suggestion 6.11: Introducing Sensitivity Analysis.
Determining how sensitive the optimal solution is to changes in
model parameters is important for every concept discussed in the
book. This beginning chapter on inventory control is the formal
introduction to this important topic. The section on sensitivity
analysis shows that a change in the optimal solution is equal to the
square root of a change in a model parameter.
Alternative Example 6.3: Paul Peterson (see Alternative Exam-
ple 6.2) has found a supplier of hole punches that offers quantity
discounts. The annual demand is 20,000 units, the ordering cost is
$100 per order, and the carrying cost is 0.5 of the unit price. For
quantities that vary from 0 to 1,999, the unit price is $10. The
price is $9.98 for quantities that vary from 2,000 units to 3,999
units and $9.96 for quantities that vary from 4,000 to 10,000 units.
Should Paul take the quantity discount?
To solve this problem, we begin by computing the economic
order quantity. This is done using the equation

ALTERNATIVE EXAMPLES
Q* 
2(20,000)(100)
($10)(0.5)
 894

The table below shows the results of the total cost analysis. Note
Alternative Example 6.1: Paul Peterson is the inventory man-
that the order quantity had to be adjusted to 2,000 and 4,000 units
ager for Office Supplies, Inc., a large office supply warehouse.
for the last two quantity discounts. In this case, the best decision is
The annual demand for paper punches is 20,000 units. The order-
not to take the quantity discount. The order quantity is 894 units,
ing cost is $100 per order, and the carrying cost is $5 per unit per
with a total cost of $204,472.

Discount Unit Order Material Ordering Carrying Total

Number Price Quantity Cost Cost Cost Cost
1 $10 894 $200,000 $2,236 $2,236 $204,472
2 9.98 2,000 199,600 1,000 4,990 205,590
3 9.96 4,000 199,200 500 9,960 209,660

Alternative Example 6.4: Steve Handel has observed the fol-

lowing demand over the lead time for a product.

Reorder Point Number of Units Probability

30 0.1
40 0.2
ROP l 50 0.3
60 0.2
70 0.20
1.00

The carrying cost is $30 per unit per year, and the stockout cost is
$50 per unit per stockout. Two orders are placed per year. Given
this information, Steve would like to determine the best safety
72 CHAPTER 6 INVENTORY CONTROL MODELS

stock policy. We begin by developing the following decision

table. We also note the following relationships:
Total cost  0 when the reorder point equals the demand
over the lead time.
Total cost  stockout cost  number of units short times stockout
cost per unit times number of orders per year  number of units
short times $50 times 2 orders per year (when the reorder point is
less than the demand over the lead time).
Total cost  total additional carrying cost  number of sur-
plus units times the carrying cost  number of surplus units times
$30 per unit (when the reorder point is greater than the expected
demand over the lead time).
Using the table that follows and the probability of the de-
mand values over the lead time, we can use decision making under
risk to determine the total expected cost of every alternative. The
solution is also presented below. As you can see, the best decision
(Alternative 4) is to have a reorder point of 60 units. The total cost
is $500. This is equivalent to having a safety stock of 10 units.

STATE OF NATURE
Alternative 30 40 50 60 70
1 (30) $ 0 $1,000 $2,000 $3,000 $4,000
2 (40) 300 0 1,000 2,000 3,000
3 (50) 600 300 0 1,000 2,000
4 (60) 900 600 300 0 1,000
5 (70) 1,200 900 600 300 0

Probability EVENT 1(30) EVENT 2(40) EVENT 3(50) EVENT 4(60) EVENT 5(70)
Alternative 0.1 0.2 0.3 0.2 0.2
1 (30) $ 0 $1,000 $2,000 $3,000 $4,000
2 (40) 300 0 1,000 2,000 3,000
3 (50) 600 300 0 1,000 2,000
4 (60) 900 600 300 0 1,000
5 (70) 1,200 900 600 300 0

Expected Cost Table

Alternative Expected Cost
1 $2,200
2 1,330
3 720
4 500 k The best alternative
5 540

Alternative Example 6.5: Kimberly Caller is in charge of four

inventory items. The inventory demand and sales price for each
item is summarized in the following table. Using ABC analysis,
how should these inventory items be controlled?

Demand Price
Item 1 20,000 $ 10.00
Item 2 8,000 100.00
Item 3 7,000 5.00
Item 4 200 5.00

Using ABC analysis, we can determine the total dollar value of
each item. This can be used to categorize each inventory item. The
results follow.
As can be seen in the table below, item 2 should be carefully
controlled. It is in the A category. Item 1 should be controlled to
some extent. It is in the B category. Items 3 and 4 should not be
carefully controlled. These items are in the C category.
Cumulative
Item Annual Unit
Number Demand Cost
2 8,000 $100
1 20,000 10
3 7,000 5 35,000
4 200 5 $0,001,000
Alternative Example 6.6: Fun and Games, Inc. sells a variety
of electronic games to children and adults. Annual demand for
super Namco games is 360. Holding cost is $1 per game and or-
dering cost is $100 per order. Fun and Games, Inc., has deter-
mined that the economic order quantity should be 268 units given
the foregoing data. What happens to the order quantity if annual
demand is underestimated by 50%? In other words, what happens
if actual annual demand is 540 units?
This is a sensitivity problem. In this case, demand increases
by a factor of 1.5 (540  1.5  360). Thus, the order quantity will
increase by the square root of 1.5. The results are new order quan-
tity  268  1.5  268  1.225  328.3.
SOLUTIONS TO DISCUSSION QUESTIONS
AND PROBLEMS
6-1. Inventory is an important consideration for managers be-
cause as much as 50% of the total assets of a company can be tied
up in inventory. Because of this large investment in inventory,
controlling inventory becomes extremely important for most orga-
nizations. On the one hand, companies will try to reduce the cost
of inventory by reducing amounts of inventory on hand. On the
other hand, however, companies realize that customer dissatisfac-
tion can be increased significantly due to low inventory levels and
stockouts. Thus, it is important to reach a fine balance between
low and high inventory levels.
6-2. The purpose of inventory control is to regulate the flow of
inventory at the various inventory storage locations within the or-
ganization. This can be done by determining how much inventory
is to be ordered and when the inventory should be ordered.
6-3. Buying inventory can be used as a hedge against inflation.
When inflation of inventory items is high, purchasing inventory at
today’s prices can be used as a hedge against future inflation of in-
ventory items. In using inventory as a hedge against inflation,
however, careful consideration should be given to carrying costs.
As more inventory is purchased as a hedge against inflation,
higher carrying costs will be paid to hold inventory over a period
of time.
6-4. Storing large quantities of inventory can eliminate short-
ages and stockouts. On the other hand, storing large quantities of
CHAPTER 6 INVENTORY CONTROL MODELS 73
Cumulative
Annual $ Percentage Percentage
Volume of Items of Cost
$800,000 22.727 77.220
200,000 79.545 96.525
99.432 99.903
100.000 100.000
$1,036,000
inventory can significantly increase the cost of carrying or holding
inventory. Therefore, a delicate balance must be sought between
increased carrying costs and shortages and stockouts. In determin-
ing how much inventory a company should have on hand to avoid
shortages and stockouts, the overall objective is to minimize carry-
ing costs and shortage or stockout costs.
6-5. Although there can be many factors to be considered in in-
ventory control, there are basically two fundamental decisions that
will have to be made. These decisions are (1) how much to order,
and (2) when to order. The simplest and the most complex inven-
tory models must answer both of these questions.
6-6. There are a number of assumptions that are made in using
the economic order quantity. It is assumed that the cost of the
items, the cost of ordering, the cost of holding inventory, and the
annual demand are known and constant. It is also assumed that
the time it takes to receive an order is known and constant. In the
basic economic order quantity model, it is assumed that stockouts
can be avoided and that there are no quantity discounts.
6-7. The major costs in determining the economic order quan-
tity include (1) the cost of the items, (2) the cost of ordering,
(3) the cost of carrying or holding inventory, (4) the cost of safety
stock, and (5) the cost of stockouts. Under the basic economic
order quantity model, it is assumed that there are no stockouts;
therefore, the cost of stockouts and the cost of safety stock are not
included in the basic model.
6-8. The most commonly used methods in actually determining
the equation for the economic order quantity are to use algebra or
calculus. When using basic algebra, expressions for ordering costs
and carrying costs are determined. These two costs are then set
equal to each other, and the equation is solved for Q, the economic
order quantity. When calculus is being used, an expression is de-
veloped for the total cost. This total cost includes ordering costs
and carrying costs. Then the first derivative of this equation is
taken and set equal to zero. This equation is solved to determine
the economic order quantity. As you would expect, both proce-
dures result in the same equation for the economic order quantity.
6-9. The reorder point specifies when an order is to be placed
for new inventory items. When the inventory drops to or below the
reorder point, an order is placed.
74 CHAPTER 6 INVENTORY CONTROL MODELS

The reorder point for the basic economic order quantity 6-18. ROP  8 days  (500 screws/day)  4,000 number 6
model is determined by multiplying the demand per period times screws
the lead time for a new order. In most cases, it is determined by D 1
multiplying the demand per day times the lead time for a new 6-19. TC  C  QCh
Q o 2
order in days.
100,000 20,000
6-10. The purpose of sensitivity analysis is to determine what ef- Cost under Lila’s policy   $10 
20,000 2
fect changes in the annual demand, the ordering cost, and the car-
rying cost will have on the economic order quantity. In general,  $0.005  $100
sensitivity analysis is used to determine what effect a change in a 100,000
Q under brother’s policy   50,000
variable in the model will have on the optimal quantity, such as 2
the economic order quantity. 100,000
Cost under brother’s policy   $10
6-11. The assumptions made in the production run model are the 50,000
same assumptions made in the economic order quantity with the 50,000
exception that the instantaneous receipt of inventory assumption is   $0.005
2
eliminated. Thus, the assumptions are that the demand is known  $145
and constant, the lead time is known and constant, quantity dis-
counts are not allowed, ordering cost and carrying cost are the Extra cost  $45;
only variable costs, and stockouts and shortages can be completely no effect on ROP.
eliminated. 6-20. D  4,000 units
6-12. When the daily production rate becomes very large, the Ch  10% of $90  $9
production run model becomes identical to the economic quantity Co  $25
model. This is because the fraction d/p approaches zero as the pro-

2(4,000)(25)
duction rate becomes very large.
a. Q*   149 units
6-13. In the quantity discount model, the carrying cost is a per- 9
centage of the unit cost. This is due to the fact that the unit cost in b. ROP  (2 weeks)  (80 per week)  160
the quantity discount model is allowed to vary or change. Thus, 4,000 149
the carrying cost per unit per year is not applicable to quantity dis- c. Total cost   $25   $9  $1,341
149 2
count models.
6-21. Co  $25
6-14. Solving a quantity discount model involves several steps.
Ch  25% of $100  $25
The first step is to compute the economic order quantity for each
discount range. The second step is to adjust the order quantity de- Q*  4,000

2D 25 25, D  8 million loads of plywood

termined in step one if the order quantity is too low to qualify for
4,000 
the discount. Furthermore, any economic order quantity values
greater than the discount range can be ignored. The third step is to
6-22. D  500 sandals; Co  $10
compute the total cost for every discount range. The fourth step is
If Q*  100,
to select that order quantity from step three which has the lowest
total inventory cost.
6-15. When the stockout cost is known, the safety stock can be
100 
2  500C  10 or
h
determined by comparing the total cost of each safety stock pol- Ch  $1, which is 20% of cost. If Ch  10% of $5  $0.50,
icy. This method requires that we know the probability of demand

2(500)(10)
over lead time and the cost of a stockout in addition to the tradi-
tional costs associated with the economic order quantity. When the Q*   141 sandals
0.50
stockout cost is not known, a service-level policy is established.
For this particular model, it is only necessary to know the proba- 6-23. Optimal order quantity is proportional to the square root of
bility of demand over lead time. This can either be a continuous or the ordering cost.
a discrete probability function. When Co  $10, Q*  20,000 screws
6-16. ABC analysis is the process of categorizing inventory into If Co  $20, Q*  20,000  2  28,284 screws
three groups. The A group is very important to the organization If Co  $30, Q*  20,000  3  34,641 screws
and requires strict monitoring and control. The B group is not as
If Co  $40, Q*  20,000  4  40,000 screws
important and selected items from this group are monitored and
controlled. The C group is not as important as group A or group B, 6-24. D  50,000 units; Co  $10; Ch  $4
and thus sophisticated inventory control techniques are not used in
controlling inventory levels for these items.
6-17. D  100,000; Co  $10; Ch  $0.005
a. Q* 
2(50,000)(10)
4
 500 units

b. ROP  (25 days)  (250 units/day)  6,250 units

Q*   2(100,000)(10)
0.005
 20,000 number 6 screws
c. Optimal number of orders per year 
50,000
500
 100
 CHAPTER 6 INVENTORY CONTROL MODELS 75

6-25. D  6,000 units development, product advertising, and research and development
Co  $10 are not related to ordering or carrying cost. Lisa must also deter-
mine which costs are related to ordering and carrying costs. See the
Ch  15% of $7  $1.05
following table, which was prepared using a spreadsheet program.

Q* 
2(6,000)(10)
1.05
 338
Cost Factor
Ordering
Cost
Carrying
Cost
Q* $6,000
Total cost  $7  6,000   1.05  Taxes $2,000
2 Q*
Processing and inspection $1,500
 10  $42,355 Bill paying 500
If new supplier is used, Ch  15% of $6.65  $1 Ordering supplies 50
Inventory insurance 600
Q  3,000 Spoilage 750
3000 6,000 Sending purchasing orders 800
Total cost  $6.65  6,000  1 Inventory inquiries 450
2 3,000
Warehouse supplies 280
 $10  $41,416
Purchasing salaries 3,000
Pampered Pet should use the new supplier and take the discount. Warehouse salaries 2,800
6-26. Co  $10; Ch  $10; D  5,000 Inventory theft 800
Purchase order supplies 500
Inventory obsolescence $0,000 $0,300
Q* 
2(5,000)(10)
10
 100 motors $6,800 $7,530

100 5,000
Cost   $10   $10  $1,000 Next, Lisa needs to determine average ordering cost and car-
2 100
rying cost. Ordering cost is computed by dividing total ordering
5,000 cu ft costs by the number of orders per year. Carrying cost is computed
Currently, the warehouse can hold  50 motors.
100 cu ft by dividing total carrying costs by the number of inventory items.
They should expand the warehouse to 10,000 cubic feet to
Number of orders 100
hold 100 motors. Number of inventory items 10,000
Ordering cost per order $68.00
50 5,000
Current cost   $10   $10 Carrying cost per unit per year $0.75
2 50
Given an annual demand of 1,000 for the new product, the EOQ of
 $1,250
424.98 can be computed using the equation presented in this chapter.
The expansion would be worth $1,250  $1,000  $250 per year.
6-30. Melinda can solve this problem by determining the proba-
6-27. D  50,000 units; Co  $10; Ch  $16 bility distribution for ordering cost. This is done by finding the total
of the frequency of ordering cost and dividing each number by the
a. Q*  2(50,000)(10)
16
 250 units total. Melinda can also determine the EOQ value for each possible
ordering cost value by using the equation presented in the chapter.
b. ROP  (35 days)  (250 units/day)  8,750 units In order to determine the EOQ for the average or expected ordering
6-28. D  12,000; Co  $30; Ch  $2 cost, Melinda can multiply the probability of each ordering cost by
the EOQ for the ordering cost. This is displayed in the following

2(12,000)(30)
table under the EXP column. Summing this column will give us the
Q*   600 units
2 resulting EOQ requested by Melinda’s boss. The results, which
Currently, number of lawn mowers that can be stored: were computed using a spreadsheet, are shown in the table that fol-
lows. As you can see, the economic order quantity is 1,890 units.
60% of 40 ft  25 ft  8 ft

5 ft  4 ft  2 ft
Order Cost Frequency Probability EOQ EXP
 120 units
$40 24 0.049 1,789 88
120 12,000 41 34 0.070 1,811 127
Current cost   $2   $30  $3,120
2 120 42 44 0.091 1,833 166
600 12,000 43 56 0.115 1,855 214
Optimal cost   $2   $30  $1,200 44 76 0.156 1,876 293
2 600
45 66 0.136 1,897 258
To increase the number of units by a factor of 5 ( 600/120), the 46 64 0.132 1,918 253
depth should also be increased by a factor of 5, that is, from 40 ft 47 45 0.093 1,939 180
to 200 ft, increase depth by 160 ft. They would be willing to pay 48 44 0.091 1,960 177
$3,120  $1,200  $1,920 on a per-year basis. 49 23 0.047 1,980 94
50 410 0.021 2,000 41
6-29. To begin with, Lisa must determine which costs are not di-
486 1.000 1,890
rectly related to ordering or carrying costs. The cost of new product
76 CHAPTER 6 INVENTORY CONTROL MODELS

6-31. D  8,000; d  40; p  150; Cs  $100; Ch  $0.30 six alternatives. Alternative 1 is to have a reorder point of 40, al-
ternative 2 is a reorder point of 50, alternative 3 is a reorder point
Q*p 
0.3(1
2(8,000)(100)
 40/150)
 2,697 scissors
of 60, and so on. The additional carrying cost is equal to $5  the
number of additional inventory items. There are six states of na-
6-32. D  10,000; d  50; p  500; Co  $40; Ch  $0.60 ture or events for this problem. Event or state of nature 1 is a de-
mand over lead time of 40 units. Event 2 is a demand of 50, event

0.60(1
2(10,000)(40) 3 is a demand of 60, and so on. The solution for this problem is
Q*   1,217 wheel bearings presented below. As you can see, the best decision is alternative 6,
 50/500)
which is to have the reorder point plus safety stock equal to 90. If
6-33. D  1,000; unit cost  $50; Co  $40; the normal reorder point is 60, the safety stock is 30 units.
Ch  0.25  unit cost 6-35. m  60;   7
Safety stock for 90% service level
Q
2(1,000)(40)
0.25(50)
 80
 sZ (at 0.90)  7  1.28  8.96  9
With discount, unit cost  (1  0.03)  $50  $48.50 6-36. Total Cost 
Unit Cost 
Q*d  0.25
2(1,000)(40)
 48.50
 81.22 Code
XX1
Demand
$7,008
which should be adjusted to minimum orderable quantity (i.e., B66 $5,994
200). 3CP0 $1,003.52
1,000 33CP $82,292.16
Original total cost  1,000  50   40 R2D2 $2,220
80
RMS $1,998.88
80
  0.25  50 Total cost  $100,516.56
2
70% of total cost  $70,347.92
 $51,000
1,000 The item that needs strict control is 33CP. Items that should not be
Discount cost  1,000  48.50   40 strictly controlled are XX1, B66, 3CP0, R2D2, and RMS.
200
200 6-37. Co  $60; Ch  $10; stockout cost  $50/unit; ROP 
  0.25  48  $49,912.50 650; number of orders  5
2
For this problem, the expected stockout cost is $50 per stock-
Therefore, North Manufacturing should take the discount.
out  5 times per year  the number of units short. There are 11 al-
6-34. Cc  $40; Ch  $5; ROP  60 units  safety stock. ternatives. Alternative 1 is to have a reorder point plus safety stock
The expected stockout cost is $50 per stockout  7 orders per of 600, alternative 2 is a reorder point of 650, alternative 3 is a re-
year  the number of units short. For this problem, there will be order point of 700, and so on. The additional carrying cost is equal

Solution for Problem 6-34

DEMAND
Event 1 Event 2 Event 3 Event 4 Event 5 Event 6
Probability 0.10 0.20 0.20 0.20 0.20 0.10
Alternative 1 $ 0 $3,500 $7,000 $10,500 $14,000 $17,500
Alternative 2 50 0 3,500 7,000 10,500 14,000
Alternative 3 100 50 0 3,500 7,000 10,500
Alternative 4 150 100 50 0 3,500 7,000
Alternative 5 200 150 100 50 0 3,500
Alternative 6 250 200 150 100 50 0

EXPECTED COST TABLE

Alternative Expected Cost
1 $8,750
2 5,605
3 3,170
4 1,445
5 430
6 125 k The best alternative
 CHAPTER 6 INVENTORY CONTROL MODELS 77

to $10  the number of additional inventory items. There are 11 Maximum inventory level  total order  total used
states of nature or events in this problem. Event or state of nature 1 during lead time
is a demand over lead time of 600 units. Event 2 is a demand of 650,  Q  3  100
event 3 is a demand of 700, and so on. The solution for this problem
is presented below. As you can see, the best decision is alternative  Q  300
10, which is to have the reorder point plus safety stock equal to Carrying cost  12(Q  300)Ch
10,500 units. If the normal reorder point is 650 units, the safety D
stock is 400 units. The total expected cost is $3,425. Order cost  C
Q* o
6-38. D  5,000; Co  $15; Ch  $0.50; d  100; t  3 D
Setting the two equal 12(Q*  300)Ch  C
Q* o
a. Q*  2(5,000)(15)
0.50
 547.7
Or, Q*  300 
5,000(15)(2)
0.50 Q*

300,000
Q*
D
b. The ordering cost is stillC , but the carrying cost
Q o Q*2  300Q*  300,000  0
will be reduced because it arrives over three weeks. Q*  717.9

Table for Problem 6-37

Event 1 Event 2 Event 3 Event 4 Event 5 Event 6

Probability 0.300 0.200 0.100 0.100 0.050 0.050
Alternative 1 $ 0 $12,500 $ 25,000 $ 37,500 $ 50,000 $62,500
Alternative 2 500 0 12,500 25,000 37,500 50,000
Alternative 3 1,000 500 0 12,500 25,000 37,500
Alternative 4 1,500 1,000 500 0 12,500 25,000
Alternative 5 2,000 1,500 1,000 500 0 12,500
Alternative 6 2,500 2,000 1,500 1,000 500 0
Alternative 7 3,000 2,500 2,000 1,500 1,000 500
Alternative 8 3,500 3,000 2,500 2,000 1,500 1,000
Alternative 9 4,000 3,500 3,000 2,500 2,000 1,500
Alternative 10 4,500 4,000 3,500 3,000 2,500 2,000
Alternative 11 5,000 4,500 4,000 3,500 3,000 2,500
Event 7 Event 8 Event 9 Event 10 Event 11
Probability 0.050 0.050 0.050 0.030 0.020
Alternative 1 $75,000 $87,500 $100,000 $112,500 $115,000
Alternative 2 62,500 75,000 87,500 100,000 112,500
Alternative 3 50,000 62,500 75,000 87,500 100,000
Alternative 4 37,500 50,000 62,500 75,000 87,500
Alternative 5 25,000 37,500 50,000 62,500 75,000
Alternative 6 12,500 25,000 37,500 50,000 62,500
Alternative 7 0 12,500 25,000 37,500 50,000
Alternative 8 0 0 12,500 25,000 37,500
Alternative 9 1,000 500 0 12,500 25,000
Alternative 10 1,500 1,000 500 0 12,500
Alternative 11 2,000 1,500 1,000 500 0

EXPECTED COST TABLE

Alternative Expected Cost
1 $33,175
2 24,775
3 18,775
4 14,075
5 10,675
6 7,925
7 5,825
8 4,350
9 3,575
10 3,425 k The best alternative
11 3,665
78 CHAPTER 6 INVENTORY CONTROL MODELS

c. Total cost for Optimal order quantity would be 51.

instantaneous delivery  547.7  0.50 100(45) 51(0.2)(17.25)
TC  100(17.25)  
 $273.85 51 2
Total cost for  1,725  88.24  87.98
installment delivery  0.50(717.9  300)  $1,901.22
 0.50(417.9) 6-43. This is a typical quantity discount problem. It is compli-
 $208.95 cated, however, by the fact that there are drawings for computers
Note: Total cost  ordering cost  carrying cost. Since ordering and trips, which must be considered as part of the quantity dis-
cost  carrying cost, total cost  2  carrying cost  Q*  Ch. count. When this is done, a quantity discount table can be devel-
Go for installment delivery. oped and used to determine the best inventory policy. The quantity
discount table is shown below.
6-39. Ch  $0.50; m  600; s  7
Safety stock for 90% service level  9 Average
Discount Discount Discount Discount Cost
Carrying cost  9  0.5  $4.50
1 0–199 0 $9.90
Safety stock for 95% service level  7  1.65  12
2 200–299 10 cans 9.39
Carrying cost  $6.00 3 300–399 30 cans 8.90
Safety stock for 98% service level  7  2.05  15 4 400–499 40 cans 8.89

Carrying cost  $7.50 Here is how the quantity discount table was determined. Dis-
6-40. Maximum inventory level  Q  5  100 count 1 represents a quantity ranging from 0 to 199 units. There is
 Q  500 no discount, and therefore the cost is simply $9.90. For discount
number two, 10 free cans of product are offered. This has a total
Carrying cost  12(Q  500)  0.50
value of $99. In addition, it is possible to receive a personal com-
5,000 puter valued at $3,000. Since there are 1,000 companies that are eli-
Ordering cost   15
Q gible, the expected monetary value for the personal computer draw-
300,000 ing is $3 (3  3,000/1,000). This represents a total discount of $102.
Setting the two equal, Q*  500 
Q* For 200 cans of product, this represents a 51-cent discount (0.51 
Q*2  500Q*  300,000  0 102/200). Therefore, the discount price is $9.39. The same type of
computations can be made for discount number three. The 30 cans
Q*  852
of free product have a value of $297, and the personal computer
Total cost  (852  500)  0.50  $176 drawing has an expected value of $3. The total discount is $300 or
Note: Total cost  2  carrying cost because ordering cost  car- $1 per unit. Therefore, the average discount price is $8.90. For dis-
rying cost. count number four, there is also a drawing for a free trip. This trip
6-41. Item 4 should be carefully controlled: has a value of $5,000 and 800 businesses are eligible for the draw-
ing. This represents a $6.25 value ($6.25  $5,000/800). Adding

2(560)(40)
this to the $396 value for the 40 free cans and the $3 expected mon-
Q*4   45 etary value for the personal computer drawing, the total discount is
0.15(150)
approximately $405. The average discount therefore is $1.01. This
The other items contribute together about 15% of total revenues.
represents a discount cost of $8.89. This information, along with the
They do not need strict quantitative control. If however, items 1
standard information for inventory control, can be used with our in-
and 2 are controlled using EOQ:
ventory control program to compute a quantity discount. The com-
puter output from this program reveals that the optimal strategy is to
Q*1  2(600)(40)
0.2(10.6)
 151 order 447 units at a total cost of $8,935.
6-44. This safety stock problem can be solved using decision mak-

 2(450)(30) ing under risk. The cost of a stockout is $13.05 ($13.05  $45.95 
Q*2   99
0.25(11.00) $32.90). Carrying cost is $7 per unit per year. The decision table on
Items 3, 4, and 5 are definitely in category C. the next page, which was prepared using a spreadsheet, shows that
the best policy is to have a reorder point including safety stock of
6-42. Co  $45; I  20%; D  100 600 units. This corresponds to a safety stock of 200 units with a nor-
mal reorder point of 400 units. Minimum EMV is $993, which corre-
Q*1  2(100)(45)
0.2(18)
 50 sponds to the alternative of 600 units for the reorder point including
safety stock.

Q*2  2(100)(45)
0.2(17.50)
 50.7

Q*3 
2(100)(45)
0.2(17.25)
 51.1
 CHAPTER 6 INVENTORY CONTROL MODELS 79

Problem 6-44 Decision Table

Total
Frequency 1 2 2 3 4 5 4 4 3 2 2 32

Probability 0.03 0.06 0.06 0.09 0.12 0.15 0.12 0.12 0.09 0.06 0.06
STATE OF NATURE
Alternative 300 350 400 450 500 550 600 650 700 750 800 EMV
300 0 653 1,305 1,958 2,610 3,263 3,915 4,568 5,220 5,873 6,525 3,466
350 350 0 653 1,305 1,958 2,610 3,263 3,915 4,568 5,220 5,873 2,845
400 700 350 0 653 1,305 1,958 2,610 3,263 3,915 4,568 5,220 2,287
450 1,050 700 350 0 653 1,305 1,958 2,610 3,263 3,915 4,568 1,791
500 1,400 1,050 700 350 0 653 1,305 1,958 2,610 3,263 3,915 1,389
550 1,750 1,400 1,050 700 350 0 653 1,305 1,958 2,610 3,263 1,112

a
600 2,100 1,750 1,400 1,050 700 350 0 653 1,305 1,958 2,610 993
650 2,450 2,100 1,750 1,400 1,050 700 350 0 653 1,305 1,958 998
700 2,800 2,450 2,100 1,750 1,400 1,050 700 350 0 653 1,305 1,129
750 3,150 2,800 2,450 2,100 1,750 1,400 1,050 700 350 0 653 1,353
800 3,500 3,150 2,800 2,450 2,100 1,750 1,400 1,050 700 350 0 1,641

minimum EMV

6-45. a. This is a typical quantity discount problem. The data 6-45. b. Given a different quantity discount schedule, we can
and results are presented below. The optimal quantity is 1,500 disks. compute the optimal order policy using the same approach. The
results are shown below.
Data
Demand rate (D) 2,000 Data
Setup/Ordering cost (S) 250 Demand rate (D) 2,000
Holding cost (H) 1 Setup/Ordering cost (S) $250
Holding cost (H) $1
Price Ranges From To Price
1 500 $10 Price Ranges From To Price
501 1,000 9.95 1 500 $10
1,001 1,500 9.9 501 1,000 9.99
1,501 2,000 9.85 1,001 1,500 9.98
1,501 2,000 9.97
Results
Results
Optimal order quantity (Q*) 1,500.33
Average inventory 750.33 Optimal order quantity (Q*) 1,001
Orders per period (year) 1.33 Average inventory 500.50
Annual Setup cost $333.33 Orders per period (year) 2
Annual Holding cost $750.33 Annual Setup cost $499.50
Unit costs (PD) $19,700.33 Annual Holding cost $500.50
Total Cost $20,783.33 Unit costs (PD) $19,960.00
Total Cost $20,960.00
80 CHAPTER 6 INVENTORY CONTROL MODELS

6-46. a. The optimal order quantity and the total inventory cost b. The solution for a situation where annual demand is
are shown below. equal to 3,000 is presented below.

Annual demand (units/year) 3,000

Annual demand (units/year) 2,000 All other input is the same.
Business days (days/year) 365
Lead time (days) 10 Optimal order price $219.92
Ordering cost ($/order) $50 Optimal order quantity 81 units
Holding cost as a fraction 0.250 Total inventory cost $663,838.54
Reorder point 82 units
Price Lower Upper Unit
Break Quantity Quantity Price
1 0 10 $220.00
The results reveal that the optimal order quantity is 81. This is
2 11 20 219.99
3 21 30 219.98 price break 9.
4 31 40 219.97 c. The solution below shows the impact of an increase in
5 41 50 219.96 annual demand to 4,000 frames:
6 51 60 219.95
7 61 70 219.94
8 71 80 219.93 Annual demand (units/year) 4,000
9 81 90 219.92 All other input is the same.
10 91 100 219.91
11 101 110 219.90 Optimal order price $219.91
12 111 120 219.89 Optimal order quantity 91 units
13 121 130 219.88 Total inventory cost $884,339.27
14 131 140 219.87 Reorder point 110 units
15 141 —1 219.86

Optimal order price $219.94 The optimal order quantity is 91 for the data above. This repre-
Optimal order quantity 61 units sents price break 10.
Total inventory cost $443,196.39 d. The optimal order quantity increases and total inventory
Reorder point 55 units cost increases. As expected, higher demand levels allow the
ability to take advantage of quantity discounts.
6-47. This is an ABC inventory problem. We can determine the
As seen in the analysis above, the optimal order quantity is 61 total dollar value of each inventory item. This is shown in the fol-
units. This represents price break 7. lowing table:

Annual
Item Annual Unit Dollar Percentage Percentage
Number Demand Cost Volume of Items of Cost

6 5,600 $400 $2,240,000 15.628 46.941

8 5,400 200 1,080,000 30.698 69.573
11 500 400 200,000 32.093 73.764
9 3,456 50 172,800 41.738 77.385
4 556 300 166,800 43.290 80.880
12 600 250 150,000 44.964 84.024
1 3,200 45 144,000 53.894 87.041
18 345 400 138,000 54.857 89.933
2 5,543 23 127,489 70.326 92.605
20 5,600 20 112,000 85.954 94.952
17 1,000 100 100,000 88.745 97.047
10 456 100 45,600 90.018 98.003
3 123 200 24,600 90.361 98.518
19 2,000 10 20,000 95.942 98.938
16 230 60 13,800 96.584 99.227
7 450 30 13,500 97.840 99.510
14 450 20 9,000 99.096 99.698
15 60 145 8,700 99.263 99.881
13 34 100 3,400 99.358 99.952
5 230 10 $4,772,300 100.000 100.000
$4,771,989
 CHAPTER 6 INVENTORY CONTROL MODELS 81

As you can see, items 6, 8, and 11 represent slightly over 70% total
dollar usage. These are A items, and they should be carefully con-
trolled. Items 9, 4, 12, 1, and 18 represent an additional 20% of
total sales. These are B items, and they should be controlled to
some extent. The other items are C items. The stockout data is not
needed in this problem. (Item 9 could also be considered an A item,
raising cumulative total $ value to 77%). Rules for breaking A, B,
C items into categories can be flexible and decided by each firm.
SOLUTION TO STURDIVANT SOUND SYSTEMS CASE
The optimal order quantity is
the increase in procurement costs is minimal. As lot size increases,
the number of orders decreases (assuming a constant requirement
level). Consequently, procurement costs will decrease with in-
creases in lot sizes.
SOLUTION TO PROFESSIONAL VIDEO
MANAGEMENT CASE
1. To determine the reorder points for the two suppliers, daily
demand for the videotape systems must be determined. Since each
video system requires two videotape systems that are connected to
it, the demand for the videotape units is equal to twice the number

C
2DCo of complete systems.
Q
h The demand for the complete video system appears to be rel-
where atively constant and stable. The monthly demand for the past
few months can be averaged, and this value can be used for the
Q  optimal order quantity average monthly demand. The average monthly sales is equal to
D  annual demand (5,000) (7,970  8,070  7,950  8,010)/4  8,000. Therefore, the
Co  procurement costs ($20) average monthly demand of the videotape systems is 16,000 units,
because two tape units are required for every complete system.
Ch  carrying costs ($6)
Annual demand is 192,000 units (192,000  12  16,000).
d  average daily demand (20) We will assume that there are 20 working days per month. In
L  lead time in days (10) other words, there are 5 working days per week. Making this as-
P  cost per unit ($60) sumption, we can determine the average daily sales to be equal to
the average monthly sales divided by 20. In other words, the daily
sales is equal to 800 units per day (800  16,000/20).
Q
2(5,000)(20)
6
 33,333  183 units To determine the reorder point for Toshiki, we must know
the lead time. For Toshiki, it takes 3 months between the time an
The reorder point is
order is placed and when the order is actually received. In other
ROP  dL words, the lead time is 3 months. Again, assuming 20 working
 20(10) days per month, the lead time for Toshiki is 60 days (60  20 
 200 (meaning they are actually ordering one cycle in 3). To determine the reorder point, we multiply the demand ex-
advance when there are 17 units on hand) pressed as units per day times the lead time in days. For Toshiki,
the reorder point is equal to 48,000 units (48,000  800  60).
Total annual cost under present system (current order level is 400
Because the reorder point will be greater than the EOQ (see num-
units):
ber 2 for EOQ calculations), the lead time will likely be more im-
Cost of equipment  5,000 units  $60  $300,000 portant for ordering more inventory.
Procurement costs  $20 per order  12.5 orders  250 For Kony, the reorder point can be computed in the same man-
Carrying costs  (400/2) units  $6/unit  $301,200 ner. Assuming again that there are 5 working days per week, we can
compute the lead time in days. For Kony, it takes 2 weeks between
$301,450 the time an order is placed and when it is received. Therefore, the
Total annual cost per optimal procurement policy: lead time in days is equal to 10 days (10  2  5). With the lead time
D Q expressed in days, we can compute the reorder point for Kony. This
TC  DP  C  C is done by multiplying the lead time in days times the daily demand.
Q o 2 h
5,000 183 Therefore, the reorder point for Kony is 8,000 (8,000  800  10).
 5,000(60)  (20)  (6) 2. To make a decision concerning which supplier to use, total in-
183 2
 300,000  546.45*  549* ventory cost must be considered for both Toshiki and Kony. Both
companies have quantity discounts. Because there are two suppli-
 $301,095.45 ers, we had to make two separate quantity discount calculations.
*Procurement costs and carrying costs are not equal, due to round- The first was for Toshiki. The second was for Kony. Toshiki had
ing to an even number of units for Q. the lowest total cost of $40,950,895.50. The EOQ for the minimum
Cost savings: cost inventory policy was 20,001. Kony had a cost of $42,406,569.
$ 301,450.00 3. Each alternative that Steve is considering would have a direct
impact on the quantity discount model and the results. The first strat-
301,095.45
egy is to sell the components separately. If this is done, the demand
$ 354.55 for videotape systems could change drastically. In addition to selling
The typical costs associated with procurement of materials the videotape units along with the complete system, additional tape
include costs of preparing requisitions, writing purchase orders, units could be demanded. An increase in demand could change the
receiving merchandise, inspecting goods, storage, updating inven- outcome of the quantity discount model. The second strategy would
tory records, and so on. These costs are usually fixed, regardless of also have an impact on the results of the analysis. At this time, two
the size of the order. While a large order may require more time, videotape systems are used for every complete system. If other
82 CHAPTER 6 INVENTORY CONTROL MODELS

videotape systems are used for every complete system. If other

videotape systems can be used as well, there will be fewer videotape
systems ordered when obtaining the complete system. At this time,
exactly two videotape systems are sold with every complete system.
Implementing the second strategy would cause this ratio to drop
below two. Again, this will change the annual demand figures.

MARTIN-PULLIN BICYCLE CORPORATION

1. Inventory plan for Martin-Pullin Bicycle Corporation. The
forecasted demand is summarized in the following table.

Jan Feb Mar Apr May June July Aug Sept Oct Nov Dec Total

8 15 31 59 97 60 39 24 16 15 28 47 439

Average demand per month  439/12  36.58 bicycles. The stan- This case can be made more interesting by asking students to trace
dard deviation of the monthly demand  24.58 bicycles. the inventory behavior with the above plan (assuming that the fore-
The inventory plan is based on the following costs and values. cast figures are accurate and ignoring the forecast errors) and to see
Order Cost  $65/order the amount of total stockout, if any. Students then can calculate the
Cost per bicycle  $102.00 lost profit due to stockout and add it to the total cost.
Holding cost  ($102.00)  (1%)  12 per year 3. A plot of the nature of the demand clearly shows that it is not a
per bicycle level demand over the planning horizon. An EOQ, for the entire
 $12.24 per year per bicycle year, therefore, may not be appropriate. Students should try to seg-
Service level  95%, with corresponding Z ment the planning horizon in a way so that the demand is more
value of 1.6425 evenly distributed and come up with an inventory plan for each of
Lead time  1 month (4 weeks) these segments (e.g., quarterly inventory planning). The challenge is
Total demand/year  439 units of bicycles then to manage the transition from one planning period to the next.
The solution below uses the simple EOQ model with reorder point
and safety stock. It ignores the seasonal nature of the demand. The SOLUTIONS TO INTERNET CASES
fluctuation in demand is dealt with by the safety stock based on
LaPlace Power and Light Co.
the variation of demand over the planning horizon (1997).
Economic order quantity (Q*) is given by: The optimal order quantity is given by:

Q*  2  (Total demand )  (Ordering Cost)

Holding Cost
Q* 
2DS
H

2(499.5)  50
41.4
where the Total demand and the Holding Cost are calculated on Q*  34.74 thousand feet
the same time unit (monthly, yearly, etc.). The reorder point is given by:
Thus, ROP  Daily demand  Lead time

Q* 
2  12.24
439  65
 68 units of bicycles  499.5
260 
(60)

2. The reorder point is calculated by the following relation: ROP  115.27 thousand feet
Reorder point (ROP)  average demand during the lead time Currently, the company is committed to take 1/12th of its annual
(m)  z  (standard deviation of the need every month. Therefore, each month the storeroom issues a
demand during the lead time (s)) purchase requisition for 41,825 feet of cable. With TC  total in-
Therefore, ventory cost,
ROP  36.58  1.6425(24.581)  77 bicycles
Safety stock (ss) is given by
Present TC  41.625
499.5
 (50)  41.625
2 
(41.4)

ss  zs  1.6425(24.581)  40 bicycles  (499.5)(414)

Inventory cost is calculated as follows:  600  861.64  209,793
Total annual Annual  $208,254.64
inventory  holding  Annual ordering cost
cost cost Optimal TC 
499.5
34.74(50)  
34.74
2 
(41.4) 
1
 Q* (Holding Cost)  ss(Holding Cost)  (499.5)(414)
2
Total Demand  718.91  719.12  206,793
 (Ordering Cost)
Q*  $208,231.03
 $416.00  $489.60  $416.00  $1321.60 Savings  Present TC  Optimal TC  $23.61
 CHAPTER 6
Ordering costs are a linear function because no matter how large
an order is or how many orders are sent in, the cost to order any
material is $50 per order.
The student should recognize that it is doubtful the firm will or
should alter any current ordering policy for a savings of only $23.
Drake Radio
1. In order to figure out the reorder points for the two suppliers,
daily demand for the FM tuner must be derived. Since one FM
tuner is required for each DR-2000 (stereo system), demand for
tuners is equal to 1  (demand for DR-2000).
Demand for DR-2000’s appears to be fairly constant and sta-
ble, based on the figures from Figure 1. An average monthly de-
mand can be calculated as follows:
(Demand for Jan.  Demand for Feb.  Demand for Mar. 
Demand for Apr.)/4
= (801  807  795  797)/4  800 per month
Assuming that there are 20 working days per month, daily
demand can be estimated as follows:
Avg. Monthly Demand  # days/months  Avg. daily demand
800  20  40 units
The reorder point is equal to daily demand times the lead time.
ROP  dL
For Collins, lead item is 2 weeks which (following the previ-
ous assumption about working days per month) is equal to 10
days. Therefore,
ROP  40 units/day  10 days  400 units,
meaning that if Drake Radio is being supplied by Collins, the firm
should reorder stock when inventory reaches a level of 400 units.
For Nitobitso, the lead time is 2 months or 40 days. Therefore,
ROP  40 units/day  40 days  1,600 units,
meaning that if Drake Radio is being supplied by Nitobitso, the
firm should reorder stock when the inventory falls to a level of
1,600 units.
2. To make a sound recommendation, total inventory costs for
both Collins and Nitobitso must be determined. Both companies
have quantity discounts.
Annual demand is estimated to be 9,600 units (800
units/month  12 months/yr.).
The first step in determining inventory costs is to determine
what the economic order is; then total costs can be derived.
Collins:
Q* 
2DC
I(P)

o 2(9,600)(50)
.25(24)
 400 units
The particular price multiplied times carrying cost percentage was
chosen based on trial and error. Whatever the EOQ turned out to
be, the price per unit was adjusted accordingly.
Using total costs, an evaluation of the price breaks due to the
quantity discount can be done:
TCQ*  (9,600/400)(50)  (400/2)6  24(9,600)  $232,800
TCP3  (9,600/501)(50)  (501/2)(5.5)  22(9,600)
 $213,535.83
The lowest total inventory cost for Collins is $213,535.83 with
EOQ of 501 units.
INVENTORY CONTROL MODELS 83
Nitobitso
2DC 
2(9,600)(100)
Q*   577.85
o
I(P) (25)(23)
TCQ*  (96,00/577.85)(100)  (577.85/2)(5.75)  23(9,600)
 $224,122.65
TCP3  (9,600/801)(100)  (801/2)(5.5)  22(9,600)
 $214,601.25
TCP4  (9,600/2001)(100)  (2,001/2)(5.25)  21(9,600)
 $207,332
The lowest total cost for Nitobitso is $207,332.39 with an EOQ of
2,001 units.
A comparison of the two lowest total cost figures indicates
that using Nitobitso as supplier would be the least costly of the
two. Ordering costs decreases and price breaks far outweigh any
carrying cost increases in this case.
3. Everything else being equal, Collins would be the best sup-
plier of FM tuners in the event of fluctuating demand. Collins’
lead time is substantially less than Nitobitso’s. Should high de-
mand occur during the time when a shipment is expected, stock-
outs could occur. With a short lead time, lost sales are kept to a
minimum. Thus, a supplier with a shorter lead time is less of a risk
to a purchaser whose product demand fluctuates a great deal.
Western Ranchman Outfitters
The EOQ for a yearly demand of 2,000, order cost of $10.00 and
holding cost of 0.12 (10.05)  $1.206 is
EOQ 
2(10)1.206
(2,000)
 182.12
The solution recommends 2,000/182  11 orders to be sub-
mitted per year; WRO orders monthly. The EOQ is about 182
pairs, as compared to 167 ordered monthly. The annual cost differ-
ence is miniscule.
There is one remaining problem which the model doesn’t
solve, but which Mr. Randell has. That is the problem of the unre-
liability of the supplier. By ordering one extra time (twelve orders
per year instead of eleven) and by ordering extra quantities judi-
ciously, Mr. Randell has managed to keep WRO almost totally
supplied with the requisite number of Levi 501s. Further, since the
actual solution is so close to the model solution, and since we have
seen that the EOQ is a robust model, Mr. Veta can feel that he is
keeping his inventory goals close to the minimum while still meet-
ing his goal of avoiding stockouts.
The conclusion is that the model has been shown to be practi-
cally valid with minor adjustments which compensate for the un-
reliability of the manufacturer.
This case differs from most in that the EOQ is just a starting
point for discussion. Students must then develop their own ap-
proach and reasoning for why the current policy is acceptable or
unacceptable.
Touro Infirmary
1. The optimum amount to order can be determined from the
EOQ formula with a price break. The optimum is
Q*  [2  1,825  10/(.2)(3.25)]  212
84 CHAPTER 6 INVENTORY CONTROL MODELS

However, the fact that the current freezer has a capacity of only 75 For the current system for which the reorder point is 17, the ex-
dinners means that that is the quantity that must be ordered at the pected cost per order cycle is
price of $3.50. 17 

To determine the reorder point, the optimum service level E  3.5  (17  x)p(x)  10  (x  17)p(x).
x0 x18
must be determined. The service level is SL  Cu /(Cu  Co),
Numerical solution yields E  17.38 per order which is $422.91
where Co is the cost of ordering one dinner more than is needed—
per year. If the freezer is ordered and a reorder point R  13 is
that dinner would be discarded and the $3.50 purchase price is lost
chosen
(Co  3.50). Ordering one dinner too few results in the charge
R13 
Cu  10. Thus, the optimum SL is 10/(10  3.50)  0.741. The
annual demand of 1,825 translates into a daily demand of 5. Thus,
E  3.25  (R  13  x)p(x)  10  (x  R)p(x).
x0 xR

demand during the 3-day lead time is Poisson distributed with a
mean of 15. Using a table of cumulative Poisson probabilities, the
smallest x such that the probability of a demand of x or less
 0.741 given a mean of 15 is x  17; this is the optimum reorder
point.
2. The total annual cost of the present method is calculated in the
following table along with the annual costs that would be realized
if the freezer was purchased. The food cost is 1,825P where P, the
price, is $3.50 for the lots of Q  75 and $3.25 for Q  212. The
order costs are 10(1,825/Q) and the holding costs are (Q/2)(.25)P.
To calculate the expected shortage plus holding cost, let p(x) 
e15(15)x/x!, the Poisson probability of a demand of exactly x dur-
ing the lead time.
Note that the freezer capacity is 225 or 13 more than the reorder
quantity of 212. Dinners are discarded only if more than 13 din-
ners remain in the freezer when the new order is received—a de-
mand (x) between zero and R  13 results in R  13  x dinners
being discarded. Trial and error numerical solution yields an opti-
mum reorder point of R  23 for the minimum E  0.88 per order
or $7.58 per year.
Annual savings are $7,086.55  $6,111.04  $975.51. A 10-
year investment of $1,800 that yields this annual savings is equiv-
alent to a rate of return in excess of 53 percent; the freezer should
be purchased.

ANNUAL COSTS
Cost Component Present Method Purchase Freezer
Food $6,387.50 $5,931.25
Order 243.33 86.08
Holding 32.81 86.13
Shortage/Spoilage 422.91 7.58

Total $7,086.55 $6,111.04