1 Chapter Three

Basically, Deterministic models keeps the condition that

all variables take values which are known exactly.
However, Deterministic models do remove some of the
assumptions made in the classical analysis or EOQ.

1. Model for discounted unit cost: Many suppliers quote
lower prices for larger orders, so a procedure is
described for finding the overall lower cost.
2. Finite Replenishment rate: This is typical of a finished
goods store at the end of a production line. Here units
arrive at a finite rate and stock accumulates during a
production run. Remove the assumption of
instantaneous replenishment used for EOQ and
calculate new optimal batch sizes.
DETERMINISTIC MODELS FOR
INVENTORY CONTROL
2 Chapter Three
Quantity Discount in Unit Cost

Remove EOQs assumption that all costs are
fixed (constant values which never change)

Address problems where costs vary with the
quantity ordered

Two main approaches: Valid Total Cost Curve
& Rising Delivery Cost
3 Chapter Three
Valid Total Cost Curve:
In practice, normally a sliding scale of unit costs is
applied, so that every unit bought has a different
price

Frequently the unit cost decreases in steps with
supplier offering a reduced price on all units if more
than a certain number are bought

There are two main characteristics of valid cost
curve:
1. The valid total cost curve always rises to the
left of a valid minimum
2. There are two possible positions for the overall
minimum cost, either at valid minimum or cost
breakpoint

4 Chapter Three
1. Valid Minimum:
The minimum point on the cost curve is
within the range of valid order quantities for
this particular unit cost

2. Invalid Minimum:
The minimum point on the cost curve falls
outside the valid order range for this
particular unit cost

5 Chapter Three
Procedure for finding the lowest Total
Cost with varying unit cost

1. Take the next lowest unit cost curve
2. Calculate the minimum point, Q= 2AS/ic
3. Is this point valid??
4. If not, calculate cost at breakpoint to the left
of valid range
5. If yes, calculate the cost of the valid minimum
6. Compare the costs of all the points considered
& select lowest
7. Finish
INV: Hendrik Lamsali
6 Chapter Three
Exercise:
Annual demand for an item is 2000 units, each
order costs $10 to place and annual holding cost
is 40% of unit cost. The unit cost depends on the
quantity ordered as follows:
Unit cost is $1 for order quantities less than 500
$0.80 for quantities between 500 and 999 each
$0.60 for quantities of 1000 or more
What is the optimal ordering policy??

Listing the variables:
A = 2000 units a year
S = $10 per order
i = 40% of unit cost a year
C = ?? (depend on order quantities)
INV: Hendrik Lamsali
7 Chapter Three
Notice that:
1) Total cost, TC, for optimal order quantity, Q, is:
TC = c x A + 2 x S x ic x A

1) Total cost for any other order quantity is:
TC = c x A + (S x A)/Q + (ic x Q)/2

Follow the Procedure:
Taking the lowest cost curve:
c = $0.60, valid for Q of 1000 or more
Q = (2)(A)(S)/(ic) = (2)(2000)(10)/(0.4)(0.60) = 408.2
This is an invalid minimum as Q is not greater than 1000
So, calculating the cost of the breakpoint:
TC = c x A + (S x A)/Q + (ic x Q)/2
= (0.6)(2000) + (10 x 2000)/1000 + (0.4 x 0.6 x 1000)/2
= $1340 a year (point A)

INV: Hendrik Lamsali
8 Chapter Three
Taking the next lowest cost curve:

c = $0.80, valid for Q between 500 and 999
Q = 2AS/ic = (2)(2000)(10)/(0.4)(0.80) = 353.6
This is an invalid minimum as Q is not between 500 and 999
So, calculating the cost of the break point at the lower end:
TC = c x A + (S x A)/Q + (ic x Q)/2
= (0.8)(2000) + (10 x 2000)/500 + (0.4x0.8x500)/2
= $1720 a year (point B)

Taking the next lowest cost curve:
c = $1.00, valid for Q less than 500
Q = 2AS/ic = (2)(2000)(10)/(0.4)(1.00) = 316.2
This is valid minimum as Q is less than 500
Then, calculating the cost at this valid minimum:
TC = c x A + 2 x S x ic x A
= (1.00)(2000) +2 x 10 x (0.4)(1.00) x 2000
= $2126.49 a year (Point C)


INV: Hendrik Lamsali
9 Chapter Three
How to Choose the best ordering policy?

Compare the results at point A, B & C:
1. Point A: Q=1000, cost= $1340 a year
2. Point B: Q=500, cost= $1720 a year
3. Point C: Q=316.2, cost= $2126.49 a year

Therefore, the best policy is to order batches
of 1000 units, placing order every six months
with total annual costs of $1340
INV: Hendrik Lamsali
10 Chapter Three
Exercise 2:
A company works for 50 weeks a year during which
demand for a product is constant at 10 units a week.
The cost of placing order, including delivery charges
is estimated to be $150. The company aims for 20%
annual return on assets employed. The supplier of
the item quotes a basic price of $250 a unit with
discount of 10% on orders of 50 units or more, 15%
on orders of 150 units or more and 20% on orders of
500 units or more. What is the optimal order quantity
for the item??
Listing the variables:
A = 10 x 50 = 500 units a year
S = $150 per order
i = 20% x c (unit cost)
INV: Hendrik Lamsali
11 Chapter Three
Follow the Procedure:
Taking the lowest cost curve:
c = $200, valid for Q of 500 or more
Q = (2)(A)(S)/(ic) = (2)(500)(150)/(0.2)(200) = 61.2
This is an invalid minimum as Q is not greater than 500
So, calculating the cost of the breakpoint to the left, Q=500:
TC = c x A + (S x A)/Q + (ic x Q)/2
= (200)(500) + (150 x 500)/500 + (0.2 x 200 x 500)/2
= $110,150 a year (point A)

Taking the next lowest cost curve:

c = $212.50, valid for Q between 150 and 500
Q = 2AS/ic = (2)(500)(150)/(0.2)(212.50) = 59.4
This is an invalid minimum as Q is not between 150 and 500
So, calculating the cost of the break point to the left, Q=150:
TC = c x A + (S x A)/Q + (ic x Q)/2
= (212.50)(500) + (150 x 500)/150 + (0.2x212.50x150)/2
= $109,938 a year (point B)
INV: Hendrik Lamsali
12 Chapter Three
Taking the next lowest cost curve:

c = $225, valid for Q between 50 and 150
Q = 2AS/ic = (2)(500)(150)/(0.2)(225) = 57.7
This is a valid minimum as Q is between 50 and 150
So, calculating the cost at this valid minimum:
TC = c x A + 2 x S x ic x A
= (225)(500) +2 x 150 x (0.2)(225) x 500
= $115,098 a year (Point C)

Compare the results at point A, B & C:
1. Point A: Q=500, cost= $110,150 a year
2. Point B: Q=150, cost= $109,938 a year
3. Point C: Q=57.7, cost= $115,098 a year
So, Choose to order in batches of 150 units with annual
cost of $110,000

INV: Hendrik Lamsali
13 Chapter Three
Rising Delivery Cost

Extended version of discounted price analysis. The
only difference is that the valid cost curve is
reversed, so we look for optimal order quantities to
the left of a valid minimum and calculate the cost
of break points at the upper limit of valid ranges.
Address changes in the reorder cost due to the
amount of delivery

Example:
Enter Sandman Plc., uses 4 tonnes of fine industrial sand
every day. This sand costs $20 a tonne to buy, and $1.90
a tonne to store for a day. Deliveries are made by
modified lorries which carry up to 15 tonnes, and each
delivery of a load or part load costs $200. Find the
cheapest way to ensure continuous supplies of sand??
INV: Hendrik Lamsali
14 Chapter Three
Solution:

Notice that unit cost is constant
Reorder cost is $200 for each lorry load
Orders up to 15 tonnes need one lorry with a
reaorder cost of $200, orders between 15 and 30
tonnes need two lorries with reorder cost of $400,
orders between 30 and 45 tonnes need three lorries
with reorder costs of $600, and so on.
Other variables:
A = 4 tonnes a day
c = $20 a tonne
I = $1.90 a tonne a day
INV: Hendrik Lamsali
15 Chapter Three
Taking the Lowest Cost Curve:
S = $200, valid for Q less than 15 tonnes
Q = (2)(A)(S)/I = (2)(200)(4)/1.90 = 29.0 tonnes

This is invalid minimum as Q is not less than 15 tonnes
Calculating the cost at the break point:

TC = c x A + (S x A)/Q + (i x Q)/2
= (20)(4) + (200x4)/15 + (1.90x15)/2
= $147.58 (Point A)

Taking the next lowest cost curve:
S = $400, valid for Q between 15 and 30 tonnes
Q = (2)(A)(S)/I = (2)(400)(4)/1.90 = 41.0 tonnes

This is invalid minimum as Q is not between 15 and 30 tonnes
Calculating the cost at the break point (to the right of the range):

TC = c x A + (S x A)/Q + (i x Q)/2
= (20)(4) + (400x4)/30 + (1.90x30)/2
= $161.83 (Point B)
INV: Hendrik Lamsali
16 Chapter Three
Taking the next lowest cost curve:
S = $600, valid for Q between 30 and 45 tonnes
Q = (2)(A)(S)/I = (2)(600)(4)/1.90 = 50.3 tonnes

This is invalid minimum as Q is not between 30 and 45 tonnes
Calculating the cost at the break point (to the right of the range):

TC = c x A + (S x A)/Q + (i x Q)/2
= (20)(4) + (600x4)/45 + (1.90x45)/2
= $176.08 (Point C)

Taking the next lowest cost curve:
S = $800, valid for Q between 45 and 60 tonnes
Q = (2)(A)(S)/I = (2)(800)(4)/1.90 = 58.0 tonnes

This is a valid minimum as Q is between 45 and 60 tonnes
Calculating the cost at the valid minimum:
TC = c x A + (2)(S)(I)(A)
= (20)(4) + (2)(800)(1.90)(4)
= $190.27 a day (Point D)
INV: Hendrik Lamsali
17 Chapter Three
Compare the results at point A, B,C & D:

1. Point A: Q=15 tonnes cost= $147.58
2. Point B: Q=30 tonnes cost= $161.83
3. Point C: Q=45 tonnes cost= $176.08
4. Point D: Q=58 tonnes cost= $190.27

So, the best choice is to order 15 tonnes at a time,
with deliveries needed every 15/4 = 3.75 days

INV: Hendrik Lamsali
18 Chapter Three
Finite Replenishment Rates
Used when the rate of production is greater than
demand, thus goods will accumulate at a finite
rate while the line is operating ( P D)

Concern with the stock of finished goods at the
end of a production line

Main Assumptions:
A single item is considered
Demand is known, constant and continuous
All costs are known exactly and do not vary
No shortages are allowed
Replenishment of stock often occurs at a finite
rate rather than instantaneously
INV: Hendrik Lamsali
19 Chapter Three
The purpose of this analysis is to find the optimal
batch size (optimal order quantity) when the
production rate is greater than demand

Other significant objectives are finding total
cost, production time, cycle time and the perfect
time to place an order (ROL)

Modified Formula EOQ:
Q = 2DCo/iCc x P/P - D

INV: Hendrik Lamsali
20 Chapter Three
Example:
Demand for an item is constant at 1800 units a year. The
item can be made at a constant rate of 3500 units a year.
Unit cost is $50, batch set-up cost is $650 and holding cost is
30% of value a year. What is the optimal batch size for the
item? If production set-up time is 2 weeks, when should this
be started?

SOLUTION:
Listing the variables we know:
D = 1800 units a year
P = 3500 units a year
c = $50 a unit
Co = $650 a batch
i = 0.3 x $50 = $15 unit a year
INV: Hendrik Lamsali
21 Chapter Three
Find the optimal batch order (optimal order quantity):

Q = 2DCo/iCc x P/P - D

= (2)(650)(1800)/15 x 3500/3500-1800

= 566.7

Production time, PT, is: PT = Q/P
= 566.7/3500 = 0.16 years
= 8.4 weeks
Cycle Time, CL, is:
CL = 2Co/iCcx A x P/P A

= (2)(650)/(15)(1800) x 3500/3500-1800
= 0.31 years/16.4 weeks
INV: Hendrik Lamsali
22 Chapter Three
Variable Cost, VC:

VC = 2 x Co x iCc x D x P D/P

= (2)(650)(15)(1800) x (3500 1800)/3500

= $4129 a year

Total Cost : TC = C x D + VC
= 50 x 1800 x 4129
= $94,129 a year
If it takes 2 weeks to set up production (lead time), then the
time to start production (replenishment) can be found from the
calculation of the Reorder level.
ROL = LT x d = 2 x (1800/52) = 70 (round up)
Then, the best policy is to start making a batch of 567 units
whenever stocks fall to 70 units.