BUAD 311 – Operations Management

Fall 2017 Final Exam Solution

Section A: Multiple Choices [18 points; 3 points each; no partial credit]

___ 1. Which of the following statement is FALSE?

A) The bottleneck of a process depends on the demand mix.
B) The bottleneck of a process has the highest utilization rate.
C) The bottleneck of a process has the highest implied utilization rate.
D) The bottleneck of a process is determined by the activity that takes the longest time.
Answer: D).

___ 2. XYZ Inc. produces two types of paper towels, called regular and super-soaker. Regular
uses 4 units of recycled paper per unit of production and super-soaker uses 7 units of
recycled paper per unit of production. The total amount of recycled paper available per
month is 15,000 units. Let X1 be the number of units of regular produced per month and X2
represent the number of units of super-soaker produced per month. The appropriate
constraint should be:
A) 4𝑋1 + 7 𝑋2 = 15000
B) 4𝑋1 + 7 𝑋2 ≤ 15000
C) 4𝑋1 + 7 𝑋2 ≥ 15000
D) 4𝑋1 = 7 𝑋2
Answer: B).

___ 3. C-town brewery brews two beers: Expansion Draft and Burning River. The raw materials
required to produce these types of beers are corn, rice and hops. The brewery currently has
500 pounds of corn, 300 pounds of rice, and 400 pounds of hops. The company formulates an
LP using these available resources to maximize the profit. The following is the sensitivity
report obtained. The company decides to increase the price of Burning River from $15 to $20
per barrel. What will be the new optimal profit?
Variable Cells
Final Reduced Objective Allowable Allowable
Cell Name Value Cost Coefficient Increase Decrease
$B$13 Expansion Draft 240 0 10 20 5
$C$13 Burning River 20 0 15 15 10

Constraints
Final Shadow Constraint Allowable Allowable
Cell Name Value Price R.H. Side Increase Decrease
$B$19 Corn used 500 3 500 100 400

1
 $B$20 Rice used 300 4 300 700 50
$B$21 Hops used 260 0 400 1E+30 140
A) 100
B) 2700
C) 2800
D) We need to resolve the formulation to know the answer.
Answer: C). Since the increase ($5) is within the allowable range, the values of optimal
decision variables do not change. Hence, the new profit will be 240*10+20*20 = 2800.

___ 4. Which of the following comparisons between EOQ and Newsvendor models is FALSE?
A) EOQ allows for recurrent orders, while Newsvendor only allows for a single order.
B) EOQ is about the trade-off between overage and underage costs, while Newsvendor is
about the trade-off between setup and holding costs.
C) In the (ROP, Q) policy, Q is obtained using EOQ, and ROP is obtained using
Newsvendor.
D) EOQ assumes known and constant demand, while Newsvendor accounts for uncertain
demand.
Answer: B). The reverse is true.

___ 5. Which of the following statements is FALSE?

A) The bullwhip effect refers to the phenomenon that demand and inventory become more
volatile as one moves upstream in the supply chain.
B) In Littlefield Labs, the WIP limit provides a way to control the flow rate.
C) Aggregate forecasts are more accurate than individual forecasts.
D) Zara achieves a quick response to customer demand by outsourcing production to
countries with low labor costs.
Answer: D). Outsourcing does not necessarily help with achieving quick response; in
fact, the contrary is often true.

___ 6. You have been appointed to take charge of Zara’s online channel (i.e., its website).
Which of the following uses of the website is most aligned with Zara's operations strategy?
A) The website should highlight promotions and discounted items (i.e., leftovers in the
stores) to enable higher sales.
B) The website should highlight promotions and discounted items (i.e., leftovers in the
stores) to better leverage risk pooling effects and improve the availability.
C) The website should help build the brand image and offer all the assortments and improve
the availability.
D) The website should help build the brand image and focus on limited assortments
(especially new and trending items).
Answer: D).

2
Section B: Problems

Q1. (22 points) Tricia Trojan sells USC Christmas-themed bags in her small shop in USC Village.
Tricia purchases the bags for $1.50 each and sells them for $5 each. Leftover bags are to be sold
as at the end of the season “sale” for $0.50. Historical data indicates that the demand for
Christmas-themed bags will follow the demand distribution below.

Q Prob(Demand=Q) Prob(Demand<=Q)

60 0.045 0.045
61 0.073 0.118
62 0.089 0.207
63 0.093 0.300
64 0.087 0.387
65 0.084 0.471
66 0.029 0.500
67 0.041 0.541
68 0.048 0.589
69 0.011 0.600
70 0.034 0.634
71 0.033 0.667
72 0.049 0.716
73 0.044 0.760
74 0.041 0.801
75 0.039 0.840
76 0.038 0.878
77 0.033 0.911
78 0.031 0.942
79 0.029 0.971
80 0.029 1.000

a) (4 points) Tricia has learned about marginal analysis, and wants to use it to decide
whether to order one more bag. What is the value of underage cost and what is the value
of overage cost?

Co =$1.50 (Purchase Cost) – $0.50 (End of Season “sale” price) = $1.00 per bag
Cu = $5 (Selling Price) – $1.50 (Purchase Cost) = $3.50 per bag

b) (4 points) Suppose that Tricia has currently ordered 69 bags, and is debating whether to
order the 70th bag. Should she order the 70th bag?

Contribution of the 70th bag: 3.50*Prob(Demand>69) – 1*Prob(Demand <=69)

3.50*0.4 – 1*0.6 = $0.8 > 0 Yes, Order the 70th bag

3
 c) (4 points) How many bags should Tricia order for the Christmas season to maximize her
expected profit?

Target Service Level or Target Fill Rate=Cu/(Cu+Co)=3.50/(3.50+1.00)=0.78 or 78%

Order 74 bags

d) (4 points) What is the stock-out probability given your answer to part c) above.

Actual Service Level given that Tricia orders 74 bags=0.801

Stockout Probability=1 – 0.801=0.199=19.9%

e) (6 points) Suppose Tricia’s supplier lowers Tricia’s cost per bag to $1.30. What is
Tricia’s optimal order size under this new offer if Christmas-themed bags are still sold for
$5.00 each and leftover bags at the end of the season are still sold at a “sale” for $0.50?

Co = $1.30 (Purchase Cost) – $0.50 (End of Season “sale” price) = $0.80 per bag
Cu = $5(Selling Price) – $1.30 (Purchase Cost) = $3.70 per bag
Target Service Level or Target Fill Rate=Cu/(Cu+Co)=3.70/(3.70+0.80)=0.82 or 82%
Order 75 bags

Q2. (30 points) Trojan BioTech is a startup that tests blood samples for a rare disease called
Anti-X. To test the disease, Trojan BioTech will first run the sample through an anti-gen
retriever, then let the sample grow in a constant temperature and humidity incubator, and finally
the sample will go through a tester and the results will be electronically transferred to the
physicians. To complete the first step (i.e., retrieval), Trojan BioTech also needs preparation kits
from an outside vendor. Each blood sample needs a preparation kit. The complete flowchart is
illustrated below:

Kits

Retrieval Growth Test

Demand Stage Stage Stage

Trojan BioTech is considering the potential entry points. Two variable options have been
proposed: a price of $120, with an estimated demand of 45 per day; or a price of 180, with an
estimated demand of 40 per day. The cost of the preparation kits is $30 per kit. For all the
following problems, we assume that Trojan BioTech will commit to a single price and satisfy the
corresponding demand.

4
 a) (4 points) Based on the information so far, draw a decision tree to specify Trojan
BioTech’s optimal price and corresponding daily gross profit (i.e., revenue – purchasing
costs).

Price = 180

Daily profit = (180 – 30)*40 = 6,000

Price = 120
Daily profit = (120 – 30)*45 =4,050

The optimal price is $180, and the corresponding daily profit is 6,000.

To meet the demand, Trojan BioTech needs to lease equipment. A retriever takes one sample at a
time and can process a sample in exactly 2 hours. An incubator is quite large and can hold lots of
samples simultaneously (similar to the cooling activity in Kristen’s Cookie case) and each
sample stays in the incubator for exactly 18 hours. A tester has six independent slots, each of
which can test a sample in exactly 1.8 hours. The daily leasing costs of the retriever, the
incubator, and the tester are $400, $800, and $600, respectively. Trojan BioTech is highly
automated and runs 24 hours a day, 7 days a week.
b) (2 points) What are the capacity of the retriever, the incubator, and the tester,
respectively?

The capacity of a single retriever is 24/2 = 12 samples per day.

The capacity of a single incubator is infinity for our purpose. (if you answer a lot or put
in some large batch size and calculate batch size * 24/18 per day, you get full credit)
The capacity of a single tester is 24*6/1.8 = 80 samples per day.

c) (2 points) How many of each kind of machine does Trojan BioTech need to lease if it sets
price at $120?

At price $120, the daily demand is 45.

Therefore, Trojan BioTech needs to lease 4 retrievers, 1 incubator, and 1 tester.

d) (2 points) How many of each kind of machine does Trojan BioTech need to lease if it sets
price at $180?

At price $180, the daily demand is 40.

Therefore, Trojan BioTech needs to lease 4 retrievers, 1 incubator, and 1 tester.

5
 e) (2 points) Considering the leasing costs, what are the optimal price decision and the
optimal profit (i.e., revenue – purchasing costs – leasing costs)?

Notice that the same numbers of machines are needed for both price points and Trojan
BioTech would incur the same daily leasing cost of 4*400 + 1*800 + 1*600 = $3,000.
Therefore, this information does not change the optimal price decision, which is $180,
while the optimal profit is $6,000 – 3,000 = $3,000, while the profit at price $120 is
$4,050 – 3,000 = $1,050.

The outside vendor for the preparation kits promises a lead time of exactly one day and charges
$120 for each delivery. Trojan BioTech’s annual cost of finance is 18.25%. (Assume that 365
days in a year. And assume that demand has no uncertainty, i.e. exactly 40 or 45 per day.)
f) (4 points) What will be the optimal order quantity and reorder point if Trojan BioTech
sets price at $120?

𝐷 = 45 per day, 𝑆 = $120 per order, 𝐻 = 30 ∗ 18.25% /365 = $0.015 per day
So 𝑄 ∗ = √2𝐷𝑆/𝐻 = 849.
The re-order point is 1 × 45 = 45 because lead time 𝐿 = 1 day.

g) (2 points) Based on your answer in f), what will be the corresponding daily inventory
related cost (excluding the purchasing cost) if Trojan BioTech sets price at $120?

𝐷 𝐻
The daily inventory related cost is 𝑄∗ 𝑆 + 2 𝑄 ∗ = $12.73.

h) (4 points) What will be the optimal order quantity and reorder point if Trojan BioTech
sets price at $180?

𝐷 = 40 per day, 𝑆 = $120 per order, 𝐻 = 30 ∗ 18.25% /365 = $0.015 per day.
So 𝑄 ∗ = √2𝐷𝑆/𝐻 = 800.
The re-order point is 1 × 40 = 40 because lead time 𝐿 = 1 day.

i) (2 points) Based on your answer in h), what will be the corresponding daily inventory
related cost (excluding the purchasing cost) if Trojan BioTech sets price at $180?

𝐷 𝐻
The daily inventory related cost is 𝑄∗ 𝑆 + 2 𝑄 ∗ = $12.

j) (3 points) How does the inventory related information change your answer in d), i.e., the
optimal price decision and the optimal profit?

6
 If the price is set to $180, our daily profit will be $3,000 − $12 = $2,988; if the price is
set to $120, our daily profit will be $4,050 − $3,000 − $12.73 = $1,037.27 . The
optimal price is still $180, and the optimal profit is $2,988.

k) (3 points) The preparation kits will expire three months after the purchase, will that
impact Trojan BioTech’s profit? Provide your reasoning.

If the price is set to $180, the maximum flow time of the preparation kits is 800/40 = 20
days; and if the price is set $120, the maximum flow time of the preparation kits is
849/45 = 19 days, both of which is (much) less than 90 days. Therefore, the threat of the
expiration does not impact Trojan BioTech’s profit.

Q3. (30 points) (Continue with the information in the previous problem) Trojan BioTech
realizes that at a higher price point, customers would have higher expectations. Specifically, at
price $180, a customer would expect to receive the result in one day, while they may tolerate a
much larger lead time for a lower price. Notice that if we did not consider the potential waiting
time, the entire processing time only takes 2+18+1.8 = 21.8 hours.
Trojan BioTech looks into its own forecast process for the daily demand and finds an incomplete
historic demand and forecast table for a comparable region at price $180. It is known that the
forecast method is exponential smoothing and a small z-table is also discovered during the
review process. For all the remaining calculations, please keep exactly two digits after the
decimal point.
z 0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1.0
P 0.54 0.58 0.62 0.66 0.69 0.73 0.76 0.79 0.82 0.84
z 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 1.9 2.0
P 0.86 0.88 0.90 0.92 0.93 0.95 0.96 0.96 0.97 0.98

a) (4 points) Fill in the three missing cells of the incomplete record (each column provides
information for a single day, the data on the right is more recent). What is the value of the
smoothing constant?
Actual Demand 44 36 42 52 44
Forecast Demand 39.8 39.84 39.8

We can calculate 𝛼 = 0.01 by solving 𝛼 × 44 + (1 − 𝛼) × 39.8 = 39.84 or 𝛼 × 36 +

(1 − 𝛼) × 39.84 = 39.8. After that, we can calculate the missing cells.

Actual Demand 44 36 42 52 44
Forecast Demand 39.8 39.84 39.8 39.82 39.94 39.98

b) (4 points) Complete the absolute deviation row of the record. Based on the data and your
answer to a), what is the mean and standard deviation of the daily demand when Trojan
BioTech sets the price at $180.
Forecast Demand 39.8 39.84 39.8
Absolute Deviation 4.2 3.84 2.2

7
 Forecast Demand 39.8 39.84 39.8 39.82 39.94
Absolute Deviation 4.2 3.84 2.2 12.18 4.06

4.2+3.84+2.2+12.18+4.06
MAD is = 5.30. The standard deviation is given by 1.25 ×MAD =
5
6.63 (or 6.62 depending on the rounding). The mean is given by 39.98.

Based on the data, Trojan BioTech believes that it is appropriate to assume that the customer
arrival follows a Poisson process with a daily demand rate of 40 when the price is set to $180 (i.e.,
the interarrival time follows exponential distribution). This arrival rate distribution can also be
accurately approximated by a normal distribution with mean 40 and standard deviation 6.32 (the
exercise you have just finished earlier provides some evidence). Trojan BioTech decides to make
sure that the average total time a sample stays in the system is limited by 22.5 hours.
c) (4 points) Will Trojan BioTech meet the 22.5-hour requirement by leasing four
retrievers?

Let us calculate the expected waiting time for the preparation stage.
40
If we lease 𝑚 = 4 retrievers, we have 𝑢 = 48 = 0.83, 𝐶𝑉𝑎 = 1, 𝐶𝑉𝑝 = 0, and 𝑇𝑞 =
𝑝 𝑢√2(𝑚+1)−1 𝐶𝑉𝑎2 +𝐶𝑉𝑝2
(𝑚 ) ≈ 1 hours. This implies we need more than 1+21.8=22.8>22.5
1−𝑢 2
hours on average. Therefore, Trojan BioTech will not be able to meet the requirement.

d) (4 points) How many retrievers does Trojan BioTech need to lease to meet the 22.5-hour
requirement?

40
If we lease 𝑚 = 5 retrievers, we have 𝑢 = 60 = 0.67, 𝐶𝑉𝑎 = 1, 𝐶𝑉𝑝 = 0, and 𝑇𝑞 =
𝑝 𝑢√2(𝑚+1)−1 𝐶𝑉𝑎2 +𝐶𝑉𝑝2
(𝑚 ) = 0.23 hours.
1−𝑢 2
Notice that there is no waiting in the growing stage, as the incubator has infinite capacity.
Furthermore, a tester has six slots with each slot is faster than a retriever and all service
times are deterministic. Therefore, there is no waiting at the test stage either when we
have five retrievers. The average total time spent is, therefore, 0.23+21.8=22.03<22.5
hours. That is, Trojan BioTech will be able to meet the requirement.

e) (4 points) The random arrival also complicates the inventory management system. If
Trojan BioTech would like to have a service rate of 98%, what will be the optimal order
quantity and reorder point if Trojan BioTech sets the price at $180?

𝐷 = 40 per day, 𝑆 = $120 per order, 𝐻 = 30 ∗ 18.25% /365 = $0.015 per day.
So 𝑄 ∗ = √2𝐷𝑆/𝐻 = 800.

8
 The optimal ordering quantity is still 800, given by the EOQ formula in the last question.
The safety stock is given by 𝑠𝑠 = 𝑧 × 6.32 = 12.64 kits. Therefore, the re-order point is
𝐿𝐷 + 𝑠𝑠 = 40 + 12.64 = 52.54 and round up to 53 kits.

f) (4 points) Trojan BioTech decides to implement the following policy: leasing five
retrievers, one incubator, and one tester, setting the price to $180, and implementing the
inventory policy you calculated in part e), what is the expected average daily profit
(revenue – purchasing costs – leasing costs – inventory-related costs)?

The fixed cost of leasing machines is $400 × 5 + 800 + 600 = $3400. The gross profit
for selling products is $(180 – 30) * 40 = 6,000. The daily inventory related cost is
Q D 800 40
( + ss) H + S = ( + 13) × 0.015 + × 120 = $12.20
2 Q 2 800
Finally, the overall daily profit is $6,000 − $3,400 − $12.20 = $2,587.80 ≈ $2,588.

g) (2 points) If Trojan BioTech implements the policy in f), on average how many samples
are in the system? (Ignore the possibility of kits becoming out-of-stock)

40
We have 𝐼 = 22.03 × (24) = 36.72 samples by Little’s law.

h) (4 points) If you are very careful, after solving g), you should realize that in the
calculation of f) (as well as part j) in the previous question), you have ignored the
inventory holding cost due to one of the four inventory types. Which type of the
inventory do we fail to consider? And what is its daily inventory holding cost? (You
don’t need to revise your answers to early questions as this daily cost is very small.)

We have accounted the holding cost of cycle inventory and safety inventory, but failed to
consider the holding cost for pipeline inventory, its daily cost is 36.72*0.015 = $0.55.