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Chapter 6
To accompany Quantitative Analysis for Management, Tenth Edition, by Render, Stair, and Hanna Power Point slides created by Jeff Heyl
Introduction
!! Inventory is an expensive and important !! !! !!
!! !!
asset to many companies Lower inventory levels can reduce costs Low inventory levels may result in stockouts and dissatisfied customers Most companies try to balance high and low inventory levels with cost minimization as a goal Inventory is any stored resource used to satisfy a current or future need Common examples are raw materials, workin-process, and finished goods
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Introduction
!! Inventory may account for 50% of the total
Labor Costs
Inventory Costs
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Introduction
!! All organizations have some type of inventory
control system !! Inventory planning helps determine what goods and/or services need to be produced !! Inventory planning helps determine whether the organization produces the goods or services or whether they are purchased from another organization !! Inventory planning also involves demand forecasting
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Introduction
!! Inventory planning and control
Planning on What Inventory to Stock and How to Acquire It Forecasting Parts/Product Demand Controlling Inventory Levels
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Inventory Decisions
!! There are only two fundamental decisions
in controlling inventory
!! How much to order !! When to order
!! Cost of the items (purchase or material cost) !! Cost of carrying, or holding, inventory !! Cost of stockouts
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Table 6.1
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of order quantity
!! Many involve personnel time !! The amount of work is the same no matter the
is one of the oldest and most commonly known inventory control techniques !! It dates from 1915 !! It is easy to use but has a number of important assumptions
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Assumptions
1.! 2.! 3.! 4.! Demand is known and constant Lead time is known and constant Receipt of inventory is instantaneous Purchase cost per unit is constant throughout the year 5.! The only variable costs are the placing an order, ordering cost, and holding or storing inventory over time, holding or carrying cost, and these are constant throughout the year 6.! Orders are placed so that stockouts or shortages are avoided completely
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costs
Q 2
AVERAGE 9 7 5 3 1 8 6 4 2 0
Table 6.2
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Number of Ordering orders placed Annual ordering cost = ! cost per per year order
D Co Q
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Q Ch 2
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Figure 6.3
Order Quantity
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!! Solving for Q
2 DC o = Q 2C h
2 DC o = Q2 Ch
2 DC o = Q = EOQ = Q * Ch
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D Co Q
Q Ch 2
2 DC o Ch
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companies !! Would like to reduce inventory costs by finding optimal order quantity
!! Annual demand = 1,000 units !! Ordering cost = $10 per order !! Average carrying cost per unit per year = $0.50
Q* =
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TC =
=
D Q Co + Ch Q 2
1,000 200 (10) + (0.5 ) 200 2
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cost of purchased items !! Given the EOQ assumptions, the annual purchase cost is constant at D ! C no matter the order policy !! C is the purchase cost per unit !! D is the annual demand in units !! It may be useful to know the average dollar level of inventory
(CQ ) 2
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annual percentage of the unit cost or price of the inventory !! This requires a new variable I= Annual inventory holding charge as a percentage of unit price or cost
C h = IC
thus,
Q* =
2 DC o IC
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Sample Problem 1
!! Patterson Electronics supplies microcomputer circuitry to a
company that incorporates microprocessors into refrigerators and other home appliances. One of the components has an annual demand of 250 units, and this is constant throughout the year. Carrying cost is estimated to be $1 per unit per year, and the ordering cost in $20 per order. To minimize cost, how many units should be ordered each time an order is placed? How many orders per year are needed with the optimal policy? What is the average inventory if costs are minimized? Suppose the ordering cost is not $20, and Patterson has been ordering 150 units each time an order is placed. For this order policy to be optimal, what would the ordering cost have to be?
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Sample Problem 2
!! The Garcia Company sells electric irons.
Annual inventory requirements is 6400 units. Price is P200 per unit. The company estimates ordering costs to be P500 per order, and carrying cost is 20% of average inventory. Calculate the following: a.! Annual ordering cost b.! Annual carrying cost c.! Total annual inventory cost for the proper lot size order
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next decision is when to order !! The time between placing an order and its receipt is called the lead time (L) or delivery time !! When to order is generally expressed as a reorder point (ROP)
ROP = Demand per day ! Lead time for a new order in days
=d!L
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120 units
inventory is depleted
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instantaneous receipt assumption does not apply !! Daily demand rate must be taken into account !! The revised model is often called the production run model
Inventory Level Maximum Inventory Part of Inventory Cycle During Which Production is Taking Place There is No Production During This Part of the Inventory Cycle
t
Figure 6.5
Time
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Q= number of pieces per order, or production run Cs= setup cost Ch= holding or carrying cost per unit per year p= daily production rate d= daily demand rate t= length of production run in days
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since we know
Total produced = Q = pt
t=
Q p
maximum
Average inventory =
and
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D Cs Q D Co Q
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Q* =
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D Cs Q
2 DC s & d# C h $ 1' ! p" %
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Annual demand= D = 10,000 units Setup cost = Cs = $100 Carrying cost = Ch = $0.50 per unit per year Daily production rate = p = 80 units daily Daily demand rate = d = 60 units daily Find: 1.! The optimal production quantity, Q* 2.! How long is the production cycle?
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Q* =
Production cycle =
Q p
4,000 = 50 days 80
2.
Q* =
( )
= 4,000 units
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Sample Problem 3
!! Flemming Accessories produces paper slicers
used in offices and in art stores. The minislicer has been one of its most popular items: Annual demand is 6,750 units and is constant throughout the year. Kristen Flemming, owner of the firm, produces the minislicers in batches. On average, Kristen can manufacture 125 minislicers per day. Demand for this slicers during the production process is 30 per day. The setup cost for the equipment necessary to produce the minislicers is $150. Carrying costs are $1 per minislicer per year. How many minislicers should Kristen manufacture in each batch?
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Total cost = DC +
where
D Q Co + Ch Q 2
D = annual demand in units Cs = ordering cost of each order C = cost per unit Ch = holding or carrying cost per unit per year
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Total cost = DC +
where
D Q Co + Ch Q 2
D = annual demand in units unit cost now variable Cs Because = ordering cost of is each order Holding C = cost per unit cost = Ch = IC I =C holding cost as acarrying percentage of the unit cost (C) = holding or cost per unit per year h
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DISCOUNT (%) 0 4 5
best choice
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Order Quantity
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discount
(2)(5,000)( 49) = 700 cars per order (0.2)(5.00) (2)(5,000 )( 49) EOQ 2 = = 714 cars per order (0.2)( 4.80) (2)(5,000 )( 49) EOQ 3 = = 718 cars per order (0.2)( 4.75) EOQ1 =
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allowable discount range !! The EOQ for discount 1 is allowable !! The EOQs for discounts 2 and 3 are outside the allowable range and have to be adjusted to the smallest quantity possible to purchase and receive the discount Q1 = 700 Q2 = 1,000 Q3 = 2,000
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each quantity
UNIT PRICE (C)
DISCOUNT NUMBER
ORDER QUANTITY (Q )
TOTAL ($)
1 2 3 Table 6.4
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Sample Problem 3
!! Dorsey Distributors has an annual
demand for a metal detector of 1,400. The cost of a typical detector to Dorsey is $400. Carrying cost is estimated to be 20% of the unit cost, and the ordering cost is $25 per order. If Dorsey orders in quantities of 300 or more, it can get a 5% discount on the cost of the detectors. Should Dorsey take the quantity discount? Assume the demand is constant.
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the exact ROP will not be known with certainty !! To prevent stockouts, it is necessary to carry extra inventory called safety stock !! Safety stock can prevent stockouts when demand is unusually high !! Safety stock can be implemented by adjusting the ROP
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ROP = d ! L
d= daily demand (or average daily demand) L = order lead time or the number of working days it takes to deliver an order (or average lead time)
to accommodate uncertain demand during lead time where ROP = d ! L + SS SS = safety stock
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ABC Analysis
!! The purpose of ABC analysis is to divide the
inventory into three groups based on the overall inventory value of the items !! Group A items account for the major portion of inventory costs
!! Typically about 70% of the dollar value but only 10% of
!! Group B items are more moderately priced !! May represent 20% of the cost and 20% of the quantity !! Group C items are very low cost but high volume !! It is not cost effective to spend a lot of time managing these items
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ABC Analysis
!! Summary of ABC analysis
INVENTORY GROUP DOLLAR USAGE (%) INVENTORY ITEMS (%) ARE QUANTITATIVE CONTROL TECHNIQUES USED?
A B C
Table 6.10
70 20 10
10 20 70
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