C

12

Inventory Management

DISCUSSION
QUESTIONS
1.

The four types of

inventoryare:

2.

Raw material
thoseitemsthatare
tobeconvertedinto
product
Workinprocess
(WIP)thoseitems
that are in the pro
cess of being
converted
Finished goods
those completed
itemsforwhichtitle
has not been
transferred
MRO
(maintenance,
repair,

and
operating supplies)
those items that
are necessary to
keep

the
transformation
processgoing
The advent of
lowcost
computing
should not be
seenasobviating
the need for the
ABC inventory
classification
scheme.
Although the
cost

of
computing has
decreased
considerably,the
cost of data
acquisition has
not decreased in
asimilarfashion.

HAPTE R

Business
organizations
still have many
items for which
the cost of data
acquisition for a
perpetual
inventorysystem
is still consid
erably higher
than the cost of
theitem.

3.

The purpose of
the ABC system
is to identify
those items that
require more
attention due to
costorvolume.

4.

Typesofcosts
holding cost:
cost of capital
invested and
space required;
shortage cost:
the cost of lost
sales

or
customers who
neverreturn; the
costoflostgood
will; order cost:
the

costs
associated with
ordering,
transporting, and
receiving the
items; unit cost:
theactualcostof
theitem.

5.

Assumptions of
EOQ model:
demand is
known and
constant over
time;leadtimeis
known and
constant; receipt
of inventory is
instantaneous;
quantity
discountsarenot

possible; the
only variable
costs are the
costs of placing
an order or
setting

up
production and
the cost of
holding or
storinginventory
over time and if
ordersareplaced
attherighttime,
stockouts or
shortagescanbe
completely
avoided.
6.

7.

8.

The

EOQ
increases as
demand
increases or as
the setup cost
increases; it
decreases as the
holding cost
increases. The
changes in the
EOQ

are
proportional to
the square root
ofthechangesin
theparameters.
Price times
quantity is not
variable in the
EOQ model, but
isinthediscount
model. When
qualitydiscounts
areavailable,the
unit purchase
priceoftheitem
depends on the
orderquantity.

Advantages of cycle
counting:
1. eliminating the
shutdown and
interruption of
production
necessary for
annual physical
inventories

2. eliminating
annual inventory
adjustments
3. providing trained
personneltoaudit
the accuracy of
inventory
4. allowingthecause
of errors to be
identified and
remedialactionto
betaken
5. maintaining
accurateinventory
records
9. A decrease in setup
timedecreasesthecostper
order, encourages more
and smaller orders, and
thusdecreasestheEOQ.
10. Discount points
below the EOQ
have higher
inventory costs,
and the prices
arenolowerthan
at the EOQ.
Pointsabove the
EOQhavehigher
inventory costs
than

the
corresponding
pricebreakpoint
orEOQatprices
thatarenolower
thaneitherofthe
price beaks or
the EOQ. (It
depends on
whether or not
there exists a
discount point
abovetheEOQ.)
11. Service level
refers to the
fraction of
customers to
whom

the
product or
service

is
delivered when
andaspromised.
12. Ifthesamecosts
hold, more will
beorderedusing
an economic
production
quantity,because
the average
inventory is less
than

the
corresponding
EOQsystem.

demand per unit

oftime,leadtime,
customer service
level,

and
standarddeviation
ofdemand.

13. In a fixed
quantity
inventory
system,whenthe
quantityonhand
reaches the
reorderpoint,an
order is placed
for the specified
quantity. In a
fixedperiod
inventory
system, an order
is placed at the
end of the
period. The
quantity ordered
isthatneededto
bring onhand
inventoryuptoa
specifiedlevel.

17. Mostretailstores
have

a
computerized
cash register
(pointofsale)
system. At the
timeofpurchase,
the computer
system
simultaneously
rings up the bill
and reduces the
inventory level
initsrecordsfor
the products
sold.

14. The EOQ model

gives quite good
results under
inexact inputs; a
10% error in
actual demand
alterstheEOQby
lessthan5%.

15. Safety stock is

inventory
beyond average
demand during
leadtime,heldto
control the level
of shortages
when demand
and/or lead time
arenotconstant;
inventorycarried
toassurethatthe
desired service
levelisreached.
16. The reorder point
is a function of:

18. Advantage of a
fixed period
system: there is
no physical
count

of
inventory when
items

are
withdrawn.
Disadvantage:
there is a
possibility of
stockout during
thetimebetween
orders.

ETHICAL DILEMMA
Settingservicelevelsto
meetinventorydemandis
amanagersjob.Settingan
85%servicelevelfor
wholebloodisan
important

184

ACTIVE MODEL
EXERCISES
judgmentcallonthepartof
the hospital administrator.
Another major disaster
means a certain shortage,
yetanyhigherlevelmaybe
hard to cost justify. Many
hospitals do develop joint
orregionalgroupstoshare
supplies.Thebasicissueis
how to put a price tag on
lifesaving medicines. This
is not an easy question to
answer, but it makes for
gooddiscussion.

ACTIVEMODEL12.1:
EconomicOrder
Quantity
(EOQ)Model
1. WhatistheEOQand
whatisthelowesttotalcost?
EOQ 200unitswitha
costof$100
2.

Whatistheannual
cost

of
CARRYING
inventory at the
EOQ and the
annual cost of
ORDERING

inventory at the
EOQof
200 units.
$50 for carrying and
also$50forordering

283
2.

How doesthis compare

to the corresponding
EOQmodel?
The run size is larger
than

the
correspondingEOQ.

3.

What is the minimal

cost?
$70.71

3.

From the graph,

what can you
conclude about
the relationship
between the
lowest total cost
and the costs of
ordering and
carrying
inventory?
The lowest total cost
occurswheretheordering
and inventory costs are
thesame.
4.

Howmuchdoesthetotal
costincreaseifthestore
managerorders

50 MORE hypodermics
thantheEOQ?50LESS
hypodermics?
Ordering more
increasescostsby$2.50or
2.5%. Ordering LESS
increasescostsby$4.17or
4.17%
5.

What happens to the

EOQ and total cost
whendemandis
doubled? When carrying
costisdoubled?
TheEOQrisesby82
units(41%)andthetotal
costrisesby$41(41%)in
EITHERcase.
6.

Scroll through
lower setup cost
values

and
describe the
changes to the
graph. What
happens to the
EOQ?
The curves seem to
dropandmovetotheleft.
TheEOQdecreases.
7.

Comment on the
sensitivityoftheEOQ
modeltoerrorsin
demandorcostestimates.
The total cost is not
verysensitivetomistakes
inforecastingdemandor
placingorders.

ACTIVEMODEL
12.2:ProductionOrder
Quantity
Model
1.

What is the optimal

productionrunsizefor
hubcaps?

4. Howdoesthiscompare
tothecorrespondingEOQ
model?
Thetotalcostisless
thanthecostforthe
equivalentEOQmodel.

CHAPTER 12 I N V E N T O R Y

END-OF-CHAPTER
PROBLEMS
12.1
Code
XX1
B66
3CP0
33CP
R2D2
RMS

Totalcost
70%oftotal
cost
$70,347.92

Theitemthatneedsstrict
control is 33CP so it is
an A item. Items that
should not be strictly
controlledareXX1,B66,
3CP0,R2D2,andRMS.
The B items will be
XX1 and B66. With so
few items, an exact
breakdown into the
general A, B, C
categoriesisflexible.
12.2Youdecidethatthe
top20%ofthe10items,
based on a criterion of
demand times cost per
unit,shouldbeAitems.
(Inthisexample,thetop
20% constitutes only
58% of the total
inventory value, but in
largersamplesthevalue
would

probably
approach 70% to 80%.)
Youthereforerateitems
F3 and G2 as A items.
The next 30% of the
items are A2, C7, and
D1; they represent 23%
of the value and are
categorized as B items.
The remaining 50% of
theitems(itemsB8,E9,
H2,I5,andJ8)represent
19% of the value and
becomeCitems.

Item
A2
B8
C7
D1
E9
F3
G2
H2
I5
J8

186
CHAPTER 12
ORY

INVENT
M ANAGEMENT

12.3Firstwerankthe
itemsfromtoptobottom
onthebasisoftheirdollar
usage.Thentheyare
partitionedoffinto
classes.

(b)EconomicOrder
Quantity(Holding
cost
$6peryear):

where:Dannualdemand,S
holdingcost
12.9D

(a)

4
14

8,100
6,800

6
2
11
9

600
400
300
100

The dollar usage

percentages do not
exactly match the
predictions of ABC
analysis. For example,
Class A items only
account for 71% of the
total, rather than 80%.
Nonetheless,

the
important finding is that
ABCanalysisdidfindthe
significantfew.Forthe
items

sampled,
particularly close control
is needed for items 3, 7,
13,and15.
12.4
7,0000.10
7,0000.35

166.67
167
unit
s.
12.12 (a)EconomicOrder
Quantity:

0.10
90

where:D
demand,S

annual
setupor
ordercost,
holding
cost

(b)Average
inventory
74.5valves

7,0000.553,850385012032
108items
(c)Numberofordersperyear
Demand

4,000

EOQ

149
26.8or27
orders
(d) Assuming 250
business days
per year, the
optimal
number of
business days
between
ordersisgiven
by:

12.7Thisproblemreverses
theunknownofastandard
EOQproblem.

60
120S,so
solvingforSresults
inS=$30.
Thatis,ifSwere$30,then
the EOQ would be 60. If
the true ordering cost
turns out to be much
greater than$30, then the
firms order policy is
orderingtoolittleatatime.
12.8 (a)EconomicOrder
Quantity(Holdingcost
$5peryear):

where:Dannualdemand,
Ssetuporordercost,H
holdingcost

(e)

(f)

12.13(a)

(b)

CHAPTER 12 I N V E N T O R Y M A N A G E M E N T

2
D
S
H

(c)

(d)

(e)
(b)

(f)ROP
where:D
annual
demand,S
12.14(a)

setupororder
cost,
H holding
cost
12.15 (a) The EOQ
assumptions are
met,sotheoptimal
order
quantityis
EOQ

S Q2

2D

2
= (150) (1)

(b)

2(250)

= 22,500
$45

(c)
(d) Given an
annual
demand of
250,

a
carrying cost
of $1, and an
order quantity
of

150,
Patterson
Electronics
must
determine
what the
ordering cost
wouldhaveto
be for the
orderpolicyof
150unitstobe
optimal. To
find the
answer to this
problem, we
mustsolvethe
traditional
economic
order quantity
equation for
the ordering
cost. As you
canseeinthe
calculations
thatfollow,an
ordering cost
of $45 is
neededforthe
order quantity
of150unitsto
beoptimal.

500
12.16 Production Order
Quantity,
noninstantaneous
delivery:

where:Dannualdemand,S
cost,ddailydemandrate,p
12.17 Production order
quantity,
noninstantaneous
delivery.
(a) D12,000/yr.
H

$.10/light
yr.

$50/setup

$1.00/ligh
t

100/day

(b)Averageholdingcost/year

(c)Averagesetupcost/year

(d)

T
o
t
a
l

1
2
,
0
0
0
)

c
o
s
t

$
1
3
4
.
1
6

(
i
n
c
l
u
d
i
n
g

$
1
3
4
.
1
6

c
o
s
t

$
1
2
,
2
6
8
.
3
2
/
y
e
a
r

o
f

g
o
o
d
s
)

P
D

$
1
3
4
.
1
6

12.18 (a)Production
OrderQuantity,
noninstantaneousdelivery:

$
1
3
4
.
1
6

1217.2or
1,217units

where:D
H
productionrate
(
$
1

(b)Imax

188

Underthequantitydiscount
pricereductionof3%:
Totalcost ordercost
holdingcostpurchase
cost

(c)

DS QH

PD
(d)
Q
2
1,000
40200
12.19AttheEconomicOrderQuantity,wehave: 0.2550
0.97
200
EOQ
1,000500.97
Thetotalcostsatthisquantityare:
200.001212.5048,500
Therefore, the pumps
should be ordered in
batchesof200unitsand
the quantity discount
taken.
Atthequantitydiscount,wehave:
Holdingcost
Orderingcost
Purchasecost
Totalcost

Holdingcost
Orderingcost
Purchasecost
Totalcost
Thequantitydiscountwill
save $480 on this item.
Thecompanyshouldalso
consider some qualitative
aspects of the decision,
such as available space,
theriskofobsolescenceof
disks, and the risk of
deterioration of the
storage medium over
time,as6,000represents
one sixth of the years
needs.

12.21 Thesolutiontoany
quantity discount model

EOQ(withdiscount)=

involves determining the

total cost of each
alternative after quantities
have been computed and
adjusted for the original
problem and every
discount.

12.20 Underpresentprice
of $50.00 per unit,
EconomicOrderQuantity:

Q
where:Dannualdemand,
Ssetuporordercost,H
holdingcost,Pprice/unit
Totalcost ordercost
holdingcostpurchase
cost

DS QH

PD
Q
2
1,00040
800.25
50

(1,000
50)

30units

300units.Thenextstepis
tocomputetotalcost.
Totalcost(withdiscount)=materialcost+
Westarttheanalysiswithno
orderingcost+
discount:
carryingcost
2(1,400)
1,400(25)
=$380(1,400)+
300
(25)
EOQ(no
discount)=

300($380)(0.2)2

.2(40

$532

0)=

,000

29.6

$117

units

$11,

Totalcost(nodiscount)=materialcost+

400

orderingcost+

$543

carryingcost

,517

$400(1,400)

1,400(25)

29.6

29.6($400)(0.2)
2

Theoptimalstrategyisto
order300unitsatatotal
costof$543,517.

12.22 EconomicOrder
$5 Quantity:
60

2DS

,0
00
$1
,1
83
$1
,1

where:Dannualdemand,S
setuporordercost,H
holdingcost,price/unit
EconomicOrder
Quantity,standard
price:

83
$5
62
,3
66

245
10

0.05
20
Totalcost
ordercost
holdingcost
purchasecost

Thenextstepistocompute
thetotalcostforthe
discount:
2
(
1,
4
0
0
)
(
2
5
)
0.2
($
38
0)
=
30.
3
unit
s
EOQ(adjusted)=
300units
Because this last economic
order quantity is below the
discounted price, we must
adjust the order quantity to

D
S
Q
H

P
D

4
5

1
0
3
0

0.
0
5

2
0

(4
5

2
0)

30

1515900
Quantity
Discount, 75
units or more.

Economic Order
Quantity,
discount over 75
units:

Because EOQ 31
and a discount is
given only on
orders of 75 or
more, we must
calculate the total
costusinga75unit
orderquantity:
Totalcost order

or more, thus we
must calculate the
total cost using a
100unit order
quantity. Calculate
total cost using 100
asorderquantity:
Totalcost ordercost
holdingcostpurchase
cost

DS QH

PD
Q
2
4510
1000.05
15.75

costholdingcost
purchasecost

DS

QH
PD
Q

45
1
0
7
5

0.
0
5

1
8.
5
0

(
4
5

1
8
.
5
0
)

7
5
2

6
34.69
832.50
$873.1
9

Quantity
Discount, 100
units or more;
Economic Order
Quantity,
discount over
100units:

EOQ

(45
15.75)

4.539.38708.75
Based purely upon
cost, the decision
should be made to
orderinquantitiesof
100,foratotalcost
of$752.63.
Itshouldbenoted,
however, that an
order quantity of
100 implies that an
orderwillbeplaced
roughly every two
years. When orders
are placed that
infrequently, ob
solescence may
becomeaproblem.
12.23 D 20,000/yr.
I 20percentof
purchasepriceper
yearinholding
costs,
whereH IP
S $40/order
P $20/tireiffewer
than 500 are
ordered;
$18/tire if
between
500 and
999 are
ordered;
and
$17/tire if
1,000 or
more are
ordered
Q20

2DS/H
= (2 20,000
40) /(.2
20)
= 632.5 (not
valid)

Q18

CHAPTER 12 I N V E N T O R Y M A N A G E M E N T

2DS/H
= (220,000
40)/(.2
18)

TC1,000 PD
HQ/2SD/Q

= 666.7(valid)
Q17

= $17
20,000
(.2
$17
1,000)/
2

2DS/H
= (220,000
40)/(.2
17)
= 686
valid)

(not

($40

20,0
00)/1
,000

Wecomparethecostof
ordering667withthecostof
ordering1,000.

TC667 PDHQ/2
SD/Q
= $18

20,000(.2
$18
667)/2
($40
20,000)/
667
= $360,000
+ $1,200
+$1,200

= $340,0
00 +
$1,700
+$800
= $342,5
00 per
year
RockyMountainshould
order1,000tireseach
time.
12.24

= $362,400
peryear

(a)
H

(b,c)Vendor:Allen
at410,TC
8,400

410

(5)

(50) 8,400(16)
$136,449.36

2
at500,TC
8,400

410
500

(5)

(50) 8,400(15.5)
$132,290

2
at1,000,TC

Vendor:Baker
at410,TC

500

2
at800,TC
8,400

800

(5)

8,400(15.10)

(50)
$129,365

8
0
0

190

CHAPTER 12

I NVENTORY M ANAGEMENT

12.25S

10,H

3.33,

Qty

Price

120
150
300
500

$33.55
$32.35
$31.15
$30.75

120
150
300
500

$34.00
$32.80
$31.60
$30.50

120
200
400

$33.75
$32.50
$31.10

120
200
400

$34.25
$33.00
$31.00

EOQ120withslightrounding
12.26CalculationforEOQ:S
(a)

(b),(c)
Qty
336
500
1000
335
400
800
1200

(d) Otherconsiderationsincludetheperishabilityofthe
chemicalandwhetherornotthereisadequatespace
inthecontrolledenvironmenttohandle1,200pounds
ofthechemicalatonetime.
12.27 (a)60;7
Safetystockfor90%servicelevelZ(at0.90)7
1.288.969
(b)ROP
12.28(a)Z1.88
(b)Safetystock
(c)ROP

12.34Bothleadtimeanddemandarevariables,soEquation
(1217)applies,inweeks.1.28for90%service.
ROP (2006)1.28dLT
where
Thesafetystockthat
minimizestotal
incrementalcostis100
units.Thereorderpoint
thenbecomes200units
100unitsor,300units.
12.30
Demand during Reorder Period
0
50
100
150
200

The safety stock that

minimizes

total
incremental cost is 50
sets. The reorder point
thenbecomes100sets50
setsor,150sets.
12.31
Safety
Stock

TheBB1setshouldthereforehaveasafetystockof30units;
ROP

12.32OnlydemandisvariableinthisproblemsoEquation
(1215)applies
(a)ROP (averagedailydemandleadtimeindays)
ZdLT
(1,0002)(2.05)(d)
2,0002.05(100) 2
2,000290

leadtime

2,290towels

(b)Safetystock 290towels
12.33Onlyleadtimeisvariableinthisproblem,so
Equation(1216)isused.
1.88for97%servicelevel
ROP (dailydemandaverageleadtimein
days)
dailydemandLT
ROP (12,5004)(1.88)(12,500)(1)
50,00023,500
73,500pages

90units.
(6625)(40,0004)

$2,000
600
750
280
12,800
800

163,750405
SoROP 1,200(1.28)(405)1,200518

1,718

cigars

12.35 Fixedperiodmodel.
Q

Targetonhandordersnotreceived

Note:ItemsofNewProductDevelopment,advertising,
andresearcharenotpartofholdingororderingcost.
192

CHAPTER 12

(b) Totalannualholdingcost= H=(200)($3)=

$600

I NVENTORY M ANAGE

MENT

(c)Totalannualordercost=
Costperorder

(d)LT4dayswith15

2.33
ROP

whereSS

Holdingcostperunit

dLT

ROP
Therefore,EOQ
12.37Annualdemand,D8,000
Dailyproductionrate,p
Setupcost,S
Holdingcost,H

(e)

SS69.99frompart(d)

(f)
(g)2%stockoutlevel

Annualholdingcost

Productionquantity,

SS (Z)(dLT) 61.61
Thelowerwemakeourtargetservice
level,thelessS.S.weneed.

(a)

dailydemand,

(b)

numberofdaysinproductionrun

(c)

numberofproductionrunsperyear
annualsetupcost

(d)

maximuminventorylevel
averageinventory

(e)

totalholdingcosttotalsetupcost

(f)

totalholdingcosttotalsetupcost4,4904,490
Savings
12.38(a)d
H
Q

400lbsofbeans

Z=2.054

INTERNET HOMEWORK PROBLEMS

Problems12.3912.51arefoundonourcompanionwebsite
atwww.prenhall.com/heizer.
12.39
SKU
A
B
C
D
E

Obviously,withsofewitems,thebreakdownsintoA,B,and
Ccannotfollowtheguidelinesexactly.

12.40

45

where:Dannualdemand,Ssetupororder
cost,Hholdingcost

Item

(b)

E102
D23
D27
R02
R19
S107
S123

Holdingcost

(c)
Q

Ordercost

100

(d) Reorderpoint:
Reorderpoint=demandduringleadtime

1,500

U11
U23

units/day6days

300

V75

12.44 Reorderpoint

30units
demandduringleadtime
500units/day14days
7,000units
Demand

CHAPTER 12 I N V E N T O R Y M A N
AGEM
ENT
12.47
EconomicOrder
Quantity,
noninstantaneous
delivery:

12.45 (a)EconomicOrder
Quantity:

Q
Q

5
0

where:Dannual
demand,Ssetupor
ordercost,Hholding
cost

(b)Averageinventory

where:Dannualdemand,S
cost,ddailydemandrate,p
12.48EconomicOrderQuantity:
(c)Numberofordersper
year

EOQ

5,000

78

2DS

64.1or64orders
(d) Assuming 250 business days per year, the
optimal number of business days between
ordersisgivenby:

where:D
cost,pprice/unit
(a)

Optimalnumberofdays
(e)Totalcostordercostholdingcost
Q

2,000102001(2,000

1,923.021,950
Note:Orderandcarryingcostsarenotequaldueto
roundingoftheEOQtoawholenumber.IfanEOQof
77.46isused,theorder
andcarryingcosts
$3,872.98.
(f)

1)2002
100100

2,000
$2,200
(b)QuantityDiscount:
Totalcost ordercostholdingcostpurchase
cost

DSQHPD
Q
2
2,000102,0001

2,000

(2,0000.75)
101,0001,500
Note:No,EOQwith200unitsandatotalcostof$2,200is
better.
12.49Underpresentpriceof$7.00perunit,Economic
OrderQuantity:

12.46(a)

Q
(b)
Q
Q

20

where:Dannualdemand,S
Hholdingcost
ForQ

where:Dannualdemand,S
cost,pprice/unit
Totalcost ordercostholdingcostpurchasecost

DS QH

PD

6,000204780.157(76,000)
478
2
251.5 250.9542,000
(c)Reorderpoint:
Reorderpoint demandduringleadtime

600units

$42,502.00

10days 24units

250 days
194
MENT

CHAPTER 12

I NVENTORY M ANAGE

Note: Order and carrying costs are not equal due to

rounding of the EOQ to a whole number. Under the
quantitydiscountpriceof$6.65perunit:
Totalcost ordercostholdingcostpurchasecost

DS QH

PD

6,000203,0000.156.65(6,0006.65)

40.001,496.2539,900
Therefore,thenewpolicy,withatotalcostof$41,436.25,
ispreferable.
12.50 EconomicOrderQuantity:

where:D
cost,Pprice/unit
(a)

90901,800
$1,980(seenoteatendof
problemregardingactual
price)
(b)Orderquantity10to50sheets:unitprice
$17.50

Totalcost

DS QH

PD
Q
2
10045510.2017.50
51
2
(17.50100)
88.2389.251,750.00
1,927.48
Note: Order and carrying costs are not equal due to
roundingtheEOQtoawholenumber.Seenoteatendof
problemregardingprice.
(c) Order quantity more than 50 sheets: unit
price$17.25

Totalcost ordercostholdingcostpurchasecost

DS QHPD
Q
2

Jan
Feb
Mar
April
May
June

10045510.2017.25
51
2
(17.25100)
88.2487.981,725.00

Averagedemandpermonth
darddeviationofthemonthlydemand
ventoryplanisbasedonthefollowingcostsandvalues.

$1,901.22

Ordercost
Costperbicycle
Holdingcost

Therefore,order51units.
Note:Orderandcarryingcostsarenotequal
duetoroundingoftheEOQtoawholenumber.
ImportantNote:Studentswilllikelycomplete
allthreesetsofcalculations,includingthe
calculationsoftotalcosts.Theyshouldbeprompted
torealizethatcalculationsoftotalcostunder(a)
and(b)areactuallyinappropriatebecausethe
originalassumptionsastolotsizewouldnotbe
satisfiedbythecalculatedEOQs.
12.51 Z 1.28for90%servicelevel
Safetystock
Reorderpoint

Servicelevel
Leadtime
Totaldemand/year
The solution below uses the simple EOQ model with
reorder point and safety stock. It ignores the seasonal
natureofthedemand.Thefluctuationindemandisdealt
withbythesafetystockbasedonthevariationofdemand
overtheplanninghorizon.
Economicorderquantity(Q*)isgivenby:
2(Totaldemand)(Orderingcost)
Q

wherethetotaldemandandtheholdingcostarecalculated
onthesametimeunit(monthly,yearly,etc.).Thus,

CASE STUDIES
ZHOUBICYCLECOMPANY

Holdingcost

2. Inventory plan for Zhou Bicycle Company. The

forecasteddemandissummarizedinthefollowingtable.

2 439 65

68unitsofbicycles

12.24

CHAPTER 12 I N V E N T O R Y M A N A G E M E N T
Carryingcost

2. Thereorderpointiscalculatedbythefollowing
relation:
Reorderpoint(ROP)

Total cost =
$301,414

Next,developanEconomicOrderQuantity,anddetermine
thetotalcosts:

Therefore,(ROP)
Safetystock
bicycles.Inventorycostiscalculatedasfollows:
Totalannual
inventory
cost

AnnualholdingcostAnnualordering
cost

where:D annualdemand,S setuporordercost,H

2.Determinetheappropriatereorderpoint(inunits).
Reorderpointdemandduringleadtime205
100

= Q*(Holdingcost)ss(Holdingcost)
2
+

TotalDemand

Q*

(Orderingcost)

$416.16$514.08$419.63
$1,349.87(roundedtointegervalues)

This case can be made more interesting by asking the

students to trace the inventory behavior with the above
plan(assumingthattheforecastfiguresareaccurateand
ignoringtheforecasterrors)andtoseetheamountoftotal

holdingcost.

3.Computethecostsavingsthatthecompanywillrealizeif
itimplementstheoptimalinventoryprocurementdecision.
Totalcost ordercostholdingcostpurchasecost

DS QH

PD
Q
2
stockout,ifany.Thestudentsthencancalculatethelost
profitduetostockoutandaddittothetotalcost.
3.Aplotofthenatureofthedemandclearlyshowsthatit
isnotaleveldemandovertheplanninghorizon.AnEOQ

fortheentireyear,therefore,maynotbeappropriate.The
studentsshouldtrytosegmenttheplanninghorizonina
way so that the demand is more evenly distributed and
comeupwithaninventoryplanforeachofthesesegments
(e.g.,quarterlyinventoryplanning).Thechallengeisthen
tomanagethetransitionfromoneplanningperiodtothe
next.Again,aplotoftheinventorybehaviormaybeof
helptothestudents.

STURDIVANTSOUNDSYSTEMS
2.

Compute the optimal order quantity. First,

determinethecostunderthepresentpolicy:

Numberoforders/year52weeks4weeks
Averageordersize5,000/13384.6or385units
Totalcost
Purchasecost5000units60/unit
Ordercost

5,000 2018365,00060
183
2

546.45 549.00300,000.00
$301,095.45

Note: Order and carrying costs are not equal due to

roundingoftheEOQtoawholenumber.
ThecostsavingsundertheEOQorderingpolicy
wouldthenbe:Costunderpresentpolicy:
$301,414.00
CostunderEOQpolicy:
3
0
1
,
0
9
5
.
4
5

3
1
8
.
5
5
whichisaverysmallsavings.
4.Thetypicalcostsassociatedwithprocurementofmaterials
include costs of preparing requisitions, writing purchase
orders, receiving merchandise, inspecting goods, storage,
updating inventory records, and so forth. These costs are
usuallyfixed,regardlessofthesizeoftheorder.Alargeorder
may require more processing time (in inspection, for
example),buttheincreaseinprocurementcostsistypically
minimal. As lot size increases, the number of orders de
creases (assuming a constant requirement level).
Consequently,procurementcoststypically decrease withan
increaseinlotsize.

VIDEO CASE STUDY

INVENTORYCONTROLATWHEELED
COACH
The 7 minute video, filmed specifically for this text, is
availablefromPrenticeHallanddesignedtosupplement
this case. A 2 minute edited version of the video also
appearsonthestudentCDinthetext.
1.

Wheeled Coach implements ABC analysis by

identifyingtheannualuseofthosehighdollar
itemsandclassifyingthemasA.Theyrepresent
some15%ofthetotalinventoryitems,but70
80%ofthetotalcost.Bitemsarethoseitems
thatareofmediumvaluethatrepresent30%of
the items and 1525% of the value. The low
dollaritemsareclassCitems,whichrepresents
5%oftheannualdollarvolume,butabout55%
ofthetotalitems.

2.

196

Hewouldalsoimplementacyclecountingsystem,
andensurethatissuesrequireengineeringchange
notices

TheinventorycontrolmanageratWheeledCoach
would want to not only have ABC analysis but
implementtightphysicalcontrolofthestockroom.

CHAPTER 12

I NVENTORY M ANAGE

MENT

2
for those items not initially included on the bill of
material. To the extent feasible, stockrooms would be
consolidated.
3. The inventory control manager would implement these
changes through effectiveleadership,hiringand trainingof
cycle counters, and effective training and education of all
staff,fromengineeringthroughcyclecounters,sothateach
understands the entire system and the importance of
maintaining accurate inventory. We would also want to be
assured that all concerned employees understand the
importance of accurate inventory records, tight inventory
control,andlockedstockrooms.Managementwouldhaveto
exhibittheproperleadershipandsupportoftheentiresystem,
includingaccuratebillsofmaterial,rapidissuingofECNs,
trainingbudgets,etc.

INTERNET CASE STUDIES*

1

MAYOMEDICALCENTER

2. Thebenefitsofbarcodesinhospitalsaremuchthe
same as in any inventory application. These benefits
includeease(lowcost)ofcollectinginventorydataand
accuracy of inventory records. Such systems in turn
contributetosystemswithlowinventoryinvestment,but
thathavematerialswhentheyareneeded.
3. A natural extension with the hospital suggests
accurate charges to patient bills, reduced pilferage, and
improvedcarethroughreductionofshortages.
4. Anaturalextensioninthesupplychainsuggestsmore
accurate inventory, which means orders placed at the
correcttimeforthecorrectquantity.Accurateinventory
records also support blanket ordering and quantity
discounts.
5. EDI and Internet connections reduce costs for both
purchaserandsupplieraswellasreducingcommunication
delay.

SOUTHWESTERNUNIVERSITY:F

KeyPoints: Thiscaseletsthestudentlookatasimple
inventoryproblemthatcanbediscussedatseverallevels.
ByusingastandardEOQformula,thestudentgetsafast,
easysolutionthatisclose.However,thecaselendsitself
tofurtherdiscussionthatcanmakethelimitationsofEOQ
readilyapparent.
1. Because this is a oneyear demand, demand violates the
EOQ assumptionofconstantdemand.Therefore,thenumber
ofordersshouldnotbeprorated(asdoesthestandardEOQ
computation) nor are all orders at the EOQ optimum of
60,000.Thetotalcostandtotalprofitwillnotbeaccurateif
thetheoreticalsolutionisused.

TheoreticalSolution: Madduxshouldorder60,000
perorderfromFirstPrinting.ThesimpletheoreticalEOQ
solutionis3 13 ordersof60,000eachforasetupcostof
$1,000,andthetotalis$310,600.Theinstructorcanaccept
thisaslessthanprecise,butadequate.Thesolutionisclose
becausethetotalEOQlineissoflat(robust)aroundthe
optimum. Alternatively, the instructor can expand the
discussiontotherealapplication.
Excel OM software output (theoretical solution) is
shownbelow.
Data

Demand rate, D
Setup cost, S
Holding cost %, I
Minimum quantity
Unit Price, P

Q* (Square root form)

Order quantity
Holding cost
Setup cost
Unit costs
Total cost
*Thesecasestudiesappearonourcompanionwebsite,
www.prenhall.com/heizer.

CHAPTER 12 I N V E N T O R Y M A N A G E M E N T

Actual Solution. The demand is not constant.

Madduxneeds200,000programsthisyear.Theprograms
willbedifferentnextyearwhenhewillalsohaveanew
forecasteddemand,dependingonhowtheteamdoesthis
year.Madduxsrealsolutionwillbemorelikethisone:
Maddux should order programs from First Printing. He
places3ordersfor60,000and1for20,000atanactual
totalcostof$308,800.
Theoreticalunitcost
Actualunitcost

Theoreticalorderingcost
Actualorderingcost

Theoreticalholdingcost
Actualholdingcost
hisaverageorder(andmaximuminventory)isonly50,000
(200,000/4ordersor[(360,000)20,000]/450,000,soa
casecanbemadethathisholdingcostis50%of1.44
(50,000/2)$18,000.
Totalprogramcost(Unitcost)(Ordering
cost)(Holding
cost)
$289,600$1,200
$18,000$308,800
2. The insert ordering includes another set of issues.
Although some students might use a standard Quantity
DiscountModelandsuggestthattheorderquantityshould
be60,000units,purchasedfromFirstPrinting,asshown
in the Excel OM printout below, the real problem is
somewhatdifferent.

Demand rate, D
Setup cost, S
Holding cost %, I

Minimum quantity
Unit price, P

Askthepotentialvendorsifthereisanadditional
discountifhebuysprogramsandinsertsfromthe
samevendor.
Askifhecanhavethesamediscountscheduleifhe
placesablanketorderforall200,000,butaskfor
releasesonapergamebasis.
Hemayalsobeabletosavemoneyifhecanreduce
his trips to Ft. Worth by combining pickups of
programsandinserts.
Hemightalsoprevailuponthevendorstoholdthe
programsandinsertsattheprintingplantuntiljust
beforethegame,reducinghisholdingcost.

Therefore,Madduxshouldorder40,000insertsfrom
FirstPrintingforeachgameatacostof$32,430pergame,
and532,430
(5games) $162,150perseason.

Unitcost $0.76540,000 $30,600

Orderingcost 5ordersmustbeplaced@40,000

inserts;

Holdingcost
(assume

5setupscost$1,500@$300each.
5%of$0.765(40,000/2) $1,530

averageinventoryis20,000).
Pergameinsertcost ($0.76540,000)($300)
(5%of$0.76540,000 2)
$30,600$300$1,530
$32,430

Perseasoninsertcost

$32,4305games

$162,150

3. Totalcostfortheseasonis:Programs $308,800
Inserts $198,750
Totalcostforseason $507,550
4.

Madduxmightdoseveralthingstoimprovehissupply
chain.

PROFESSIONALVIDEOMANAGEMENT
2.

To determine the reorder points for the two

suppliers, daily demand for the videotape
systemsmustbedetermined.Eachvideosystem
requires two videotape systems that are
connected to it, thus the demand for the
videotapeunitsisequaltotwotimesthenumber
ofcompletesystems.
Thedemandforthecompletevideosystemappearsto
berelativelyconstantandstable.Themonthlydemandfor
thepastfewmonthscanbeaveraged,andthisvaluecanbe
usedforthe

Q* (Square root form)

Order quantity
Holding cost
Setup cost
Unit costs
Total cost

Madduxneeds40,000insertsforeachgameandmustorderthemonapergamebasis.Insertsfor
eachgameareunique,asstatisticsandlineupforeachteamchangesastheseasonprogresses.If
60,000peoplearegoingtoattendthegame,then40,000insertsarerequired(2of3peopleor2/3
of60,000).Therefore,thequantitydiscountissue,althoughitshouldbeevaluated,takessecond
placetothenecessityofordering40,000insertsforeachgame.

198

CHAPTER 12

I NVENTORY M ANAG

EMENT

averagemonthlydemand. The average monthly sales is

equalto(7,970 8,0707,950 8,010)/48,000.Therefore,
theaveragemonthlydemandofthevideotapesystemsis
16,000units,becausetwotapeunitsarerequiredforevery
complete system. Annual demand is 192,000 units
(192,0001216,000).
Wewillassumethatthereare20workingdaysper
month (5 working days per week). Making this
assumption,wecandeterminetheaveragedailysalesto
beequaltotheaveragemonthlysalesdividedby20.In
otherwords,thedailysalesareequalto800unitsperday
(80016,000/20).
TodeterminethereorderpointforToshiki,wemust
know the lead time. For Toshiki, it takes 3 months
betweenthetimeanorderisplacedandwhentheorderis
actually received. In other words, the lead time is 3
months.Again,assuming20workingdayspermonth,the
leadtimeforToshikiis60days(6020 3).Inorderto

determinethereorderpoint, we multiply the demand,

expressedasunitsperday,timestheleadtimeindays.
ForToshiki,thereorderpointisequalto48,000units
(48,000 800 60). The reorder point will be greater
than the EOQ (see question 2 for EOQ calculations),
thus the lead time will likely be more important for
orderingmoreinventory.
ForKony,thereorderpointcanbecomputedinthe
samemanner.Assumingagainthatthereare5working
daysperweek,wecancomputetheleadtimeindays.
ForKony,ittakes2weeksbetweenthetimeanorderis
placedandwhenitisreceived.Therefore,theleadtime
indaysisequalto10days(1025).Withtheleadtime
expressedindays,wecancomputethereorderpointfor
Kony.Thisisdonebymultiplyingtheleadtimeindays
timesthedailydemand.Therefore,thereorderpointfor
Konyis8,000(8,00080010).
2. Tomakeadecisionconcerningwhichsupplierto
use, total inventory cost must be considered for both
Toshiki and Kony. Both companies have quantity
discounts.Becausetherearetwosuppliers,wehadto
maketwoseparatequantitydiscountcomputerruns.The

firstrunwasforToshiki.ThesecondrunwasforKony.
Toshiki had the lowest total cost of $40,950,895. The
EOQfortheminimumcostinventorypolicywas20,001.
Konyhadacostof$42,406,569.
3. EachalternativethatSteveisconsideringwouldhave
a direct impact on the quantity discount model and the
results. The first strategy is to sell the components
separately. If this is done, the demand for videotape
systemscouldchangedrastically. Inadditiontoselling
the videotape units along with the complete system,
additionaltapeunitscouldbedemanded.Anincreasein
demandcouldchangetheoutcomeofthequantitydiscount
model.Thesecondstrategywouldalsohaveanimpacton
theresultsoftheanalysis.Ifothervideotapesystemscan
be used as well, there will be fewer videotape systems
orderedwhenobtainingthecompletesystem.Atthistime,
exactly two videotape systems are sold with every
completesystem.Implementingthesecondstrategywould
causethisratiotodropbelowtwo.Again,thiswillchange
theannualdemandfigures.
4

WESTERN RANCHMAN OUTFITTERS

(WRO)

TheEOQforayearlydemandof2,000,ordercostof$10.00,
and
holdingcostof0.12(10.05)
2(10)(2,000)
EOQ

Thesolutionrecommends2,000/18211orderstobesubmitted
peryear;WROordersmonthly.TheEOQisabout182pairs,
as compared to 167 ordered monthly. The annual cost
differenceisminimal.

There is one remaining problem that the

model doesnt solve, but which Mr. Randell has.
That is the problem of the unreliability of the
supplier. By ordering one extra time (12 orders
per year instead of 11) and by ordering extra
quantities judiciously, Mr. Randell has managed
to keep WRO almost totally supplied with the
requisite number of Levis 501. Further, because
the actual solution is so close to the model
solution, and because 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 meeting his goal of
avoiding stockouts.
Theconclusionisthatthemodelhasbeenshownto
be practically valid with minor adjustments that
compensatefortheunreliabilityofthemanufacturer.
ThiscasediffersfrommostinthattheEOQisjusta
startingpointfordiscussion.Studentsmustthendevelop
their own approach and reasoning for why the current
policyisacceptableorunacceptable.
5

LAPLACEPOWERANDLIGHTCO.

Theoptimalorderquantityisgivenby:
Q*

2DS

2(499.5)50

41.4

Q* 34.74thousandfeet
Thereorderpointisgivenby:
ROP=DailydemandLeadtime
499.5

ROP=115.27thousandfeet
Currently,thecompanyiscommittedtotake1/12thofits
annual need every month. Therefore, each month the
storeroomissuesapurchaserequisitionfor41,625feetof
cable.

PresentTC

= 600+861.62+206,793
= $208,254.62

OptimumTC

= 718.91+719.12+206,793

= $208,231.03
Savings PresentTCOptimumTC

$23.59

Orderingcostsareassumedtobealinearfunctionbecause
nomatterhowlargeanorderisorhowmanyordersaresent
in,thecosttoorderanymaterialis$50perorder.
1.206

Thestudentshouldrecognizethatitisdoubtfulthefirm
willorshouldalteranycurrentorderingpolicyforasavings
ofonly$23.