+6'

MODEL 2: EOQ without Instantaneous (noninstantaneous) Receipt (Fixed-Order Quantity Mode with !sa"e)
This model sometimes called Production Order Quantity Model. In the basic model we have assumed that the entire inventory, which is ordered, arrives simultaneously. In many cases, however, this is not a valid assumption, because the vendor delivers the order in partial shipment or portions ever a period of time. In such cases inventory is being used while new inventory is still being received and the inventory does not build up immediately to its maximum point. Instead, it builds up gradually when inventory is received faster than it is being used then it declines to its lowest level as incoming shipments stop and the use of inventory continues. This version of the !OQ model is "nown as #Noninstantaneous Receipt Model$ also referred to as the #Gradual Usage Model $ and #Production Lot Size Model. In this, noninstantaneous receipt model, the order %uantity is received gradually over time, and the inventory level is depleted at the same time it is being replenished. This concept is illustrated in &ig.'. (e can apply the above stated to an optimum production lot si)e, where the finished goods are being sold while each lot is produced. In this case, the inventory of finished goods doesn*t build up immediately to its maximum point, as in case of Model+. Instead, it builds up gradually as goods are produced faster than they are being sold then it declines to its lowest point as production of a particular batch ceases although sales continue ,see fig '-. Inventory level Optimal order.lot si)e ,unitsInventory rises as incoming shipments ,or production!xceeds usage.sales Maximum inventory level ,Imax-, ,Incoming 0hipments or production stops-1 or 12 or Q2
7 into 9-./ ,/8

Production /ate

Inventory declines as use.sales continue

inventory t+ 0upply begins supply ends t2 t4

3ew receipts.production begin Time

&ig. ' 5 Inventory with receipt over time.

+6'

+6G

:et

/ ; <aily receipt.production rate in units c ; use rate in units daily

EOQ Mode
12 ;
>,49?-.!,+ 8 c./-=

OL# Mode
Q2 ;
>,49s-.!,+ 8 c./-=

12 ,M@- ;

>,49p?-.A,+ 8 c./-=

Q2 ,M@-;

>,49p.s-.A,+ 8 c./-=

Imax ; 1o,+ B c./t+ ; 12 . / t4 ; Imax.9 t2 ; t+ C t4 ; 12.9 De ;

Imax ; Qo,+ B c./t+ ; Qo./ t4 ; Imax.9 t2 ; t+ C t4 ; Qo.9

>49?!,+ 8 c./-=

De ;

>49s!,+ 8 c./-=

Exa$p e %2: E)mir (ine 9o. bottles 6222 cases of a particular rose wine annually. The set8up cost per run is F2 M@. &actory cost is 6 M@ per case. 9arrying costs on finished goods inventory is 42 7. Production rate is +22 cases per day and sales amount to +Gcases.day. How many cases should be bottled per production runI #o ution : Q2 ;
>,49s-.Ap,+ 8 c./-=

>4,6222-,F2-.6,2.42-,+ 8 +G.+22-=

; +24' 9ases./un

+6G

+66

Exa$p e %% : J plastics moulding firm produces and uses 4G 222 Teflon bearing inserts annually. The cost of setting up for production is K2 M@ and the wee"ly rate is +222 units. If the production cost is 6.62 M@ per unit and the annual carrying cost is +.62 M@ per unit, how many units should the firm produce during each production runI (hat is the maximum inventory that the firm will stoc"I #o ution : The demand and the production rates must be in the same units, so we arbitrarily put both into annual terms, assuming a 648wee" year. Q2 ; >,49s-.!,+ 8 c./-= ; ; 42G2 Inserts./un
>4,K2-,4G222-.,+.62,+ 8 4G222.64222--=

t+ ; Q2 . / ; 42G2 . +222 ; 4 wee"s so the firm will be producing inserts about every month. Imax ; Q2 ,+ B c./- ; 42G2,+84G222.64222- ; +2FL.6 Inserts Exa$p e %& : The !ge 9reamery 9o. produces ice8cream bars for vending machines and has an annual demand for K4222 bars. The 9o. has the capacity to produce G22 bars per day. It ta"es only a few minutes to adMust the production set8up cost estimated at K.62 M@ per set up for the bars, and the firm is reluctant to produce too many at one time because the storage cost ,refrigeration- is relatively high at +.62 M@.bar.year. The firm supplies vending machines with its # !ge bars # on 'N2 days of the year. a- (hat is the most economical number of bars to produce during any one runI a- (hat is the optimal length of the production run in daysI c- (hat is the total inventory costI d- (hat is the maximum inventory levelI #o ution : aQ2 ; >,490-.!,+ 8 c./-= ; >4,K4222-,K.6-.,+.6-.,+ 8 ,K4222.'N2-.G22-= ; +422 ?ars./un t+ ; Qo./ ; +422.G22 ; ' <ays to ; Qo.9 ; +422.K4222 ; 2.2+K Oear P N <ays production

b-

c-

De; 49s!,+ 8 c./- ; ; F22 M@

4,K4222-,K.6-,+.6-R+ 8 ,K4222.'N2-.G22Q

+66

+6N

d-

Imax ; Qo,+8c./- ; +422,2.6- ; N22 ?ars R 32 ; 9.Q2 ; K4222.+422 ;N2 runs .year Q

Exa$p e %' : J contractor has to supply +2 222 bearings per day to an automobile manufacturer. He finds that, when he starts a production run, he can produce 46222 bearings per day. The cost of holding a bearing in stoc" for one year is 2.24 M@ and the set8up cost of a production is +L M@. How many times should the production runs occurI #o ution: Q2 ; >49s.!,+ 8 c./-= ; ; +26 222 ?earings
,4x+2222x+L-.,,2.24.'N6-,+ 8 +2222.46222--

3o ; 9.Qo ; ,+2222x'N6-.+26222 ; 'G.KN P '6 /uns Exa$p e %(: J firm has a yearly demand for 64222 units of a product, which it produces. The cost of setting up for production is L2 M@ and wee"ly production rate is +222 units. The carrying cost is '.62 M@.unit.year. How many units should the firm produce on each production runI #o ution : Q2 ;
>,49s-.!,+ 8 c./-=

,4x64222xL2-.,'.62,+ 8 +.+-

;S

They should have an infinite ,continuous- run. Exa$p e %) : Mr. <emir wonders what effect an annual inventory costs will result if he allows his supplier to deliver the T +K+' valve orders gradually rather than all at once. The analyst analyses this re%uest and develops these estimates5 9 ; +2222 valves.year ! ; 2.G2 M@.valve.year ? ; 6.62 M@.order c ; G2 valves per day ,+2222 values.year/ ; +42 valves per day. a- 9alculate the !OQ. b- 9alculate the total inventory costs. +6N

+6K

c- 0hould the supplier be allowed to deliver valves graduallyI #o ution : a- The !OQ5 1O ; >,49?-.!,+ 8 c./-= ; ; N4G.4N valves b- The new total inventory costs are5 De;
>49?!,+ 8 c./-= ; >4x+2222x6.6x2.G,+ 8 G2.+42-= >,4x+2222x6.6-.2.G,+ 8 G2.+42-=

;+K+.4K M@

c- The !OQ and total inventory costs from example 4', when the valves were delivered all at once were !OQ ; 64G.G valves De ; 42F.KN M@

The estimated savings to the 9o. for allowing its supplier to deliver the T +K+' valve gradually are 0avings ; 8+K+.4K C 42F.KN ; 'L.62 M@ .year Resu t: The 0upplier should be allowed to deliver the T +K+' valves gradually. Exa$p e %* : J large hotel serves ban%uets and several restaurants from central "itchen in which labour is shifted among various stations and Mobs. 0alad consumption ,demand- is virtually constant and "nown to be '2 222 0alads.year. 0alads can be produced at a rate of G6222.year. 0alads cost 2.G2 each and it costs GM@ to set up the salad line. 9arrying costs of salads, high because of spoilage, are estimated to be F27 of the cost of a salad. 3o stoc" outs are allowed. The hotel would li"e to establish an operating doctrine for salad operation. #o ution: &irst we can set the reorder point at /2 ; 2, because labour can be shifted to the salad operation instantaneously, and the production rate is greater than the demand rate. &inding Q2 Q2 ; >,49s-.,Ap-,+ 8 c./-= ; ; +G+G 0alads Exa$p e %+ :
>,4x'2222xG-.,2.Fx2.G-,+ 8 '2.G6-=

+6K

+6L

J)im, 9orporation is currently purchasing sales units faster than it is able to sell them as a result management has re%uested a re8evaluation of its ordering policy. Jn analysis of the current sales mar"et reveals the following anticipated annual demand +2222 units, daily sales '22 units, daily arrivals of units G22 units. The relevant cost data, obtained from the sales office is5 order cost +6 M@.order, @nit cost +.62 M@, carrying cost 427 at unit cost. <etermine the order policy that J)im should use. #o ution: 12 ; >,49?-.Ap,+ 8 c./-= ; ; 4222 units
>,4x+2222x+6-.2.42,+.62-,+ 8 '22.G22-=

JAIM should initiate an order policy re%uiring lot shipments of si)e 4222 units. De ;
>49pA?,+ 8 c./-=

>4x+2222x+6x2.42x+.62,+ 8 '22.G22-=

; +62 M@

Total 9ost ; Da C De ; +2222 +.62 C +62 ; +6+62 M@ to ; ,1o . 9- 'N6 ; ,4222 . +2222-'N6 ; K' days 32 ; 9.1o ; +2222.4222 ; 6 orders . year Exa$p e &,: J?98:ite., Inc., a manufacturing concern produces fixtures for use in one of its assemblies. The department producing the fixtures is capable and producing N462 units.wee". However, total current demand is only 6222 fixtures . wee". The firm operates 64 wee"s.year and has developed the following pertinent cost data5 unit cost of manufactured fixtures set8up cost holding cost.unit.year K.62 M@ +2G M@ 2.+2 M@

To maintain a smooth flow of materials, the production department re%uires a G8wee" lead8time on production re%uests. @sing this information, determine the following5 a- Optimal lot si)e ,optimal production %uantity-, b- Total annual inventory cost, c- The reorder point. #o ution : aQ2 ;
>,49s-.!,+ 8 c./-=

,,4x6222x64x+2G-.2.+2,+ 8 6222.N462-=

; 64222 fixtures Thus the optimal production lot si)e ,O:0- is 64 222 fixtures per run. bDe;
>49s!,+ 8 c./-= ; >4,6222x64-,+2G-,2.+2-,+ 8 6222.N462-=

+ 2'2 M@

+6L

+6F

The total annual inventory cost, given a optimal lot si)e of 64222 fixtures is +2'2 M@.year. c/2 ; clt C tlt ; 6222 G ; 42 222 fixtures

The reorder point is 42222 fixtures. 3ote5 This policy re%uires 6 production runs per year. 32 ; 9.Q2 ; ,6222 x 64-.642 222 ; 6 runs Exa$p e &-: J toy manufacturer uses GL.222 /ubber wheels per year for its popular dumb truc" series. The firm ma"es its own wheels, which it can produce at a rate of L22 per day. The day trun"s are assembled uniformly over the entire year. 9arrying cost is +.22 M@.wheel.year. 0et up cost for a production run of wheels is G6 M@. The firm operates 4G2 days per year. <etermine each of the following abcdeOptimal run si)e, Minimum total annual cost of carrying and set up. 9ycle time /un time Imax, i.e. maximum inventory level.

#o ution: a- Q2; 49s.!,+ 8 c./- ; >4,GL222-,G6-=.>+,+ 8 422.L22-= ; 4G22 wheels b- Do ; >49s!,+ 8 c./-= ; >4,GL22-,+ 8 422.L22-G6= ; +L22 M@ c- to ; Qo.9 ; 4G22. ,GL22.4G2- ; +4 days Thus a run of wheels will be made every +4 days. d- t+ ; Qo./ ; 4G22.L22 ; ' days Thus each run will re%uire ' days to complete. e- Imax ; Qo,+8c./- ; 4G22,+8 422.L22- ;+L22 wheels Exa$p e &2: Jssume that The Uul 9arpet 0tore in I)mir has its own manufacturing facility in which it produces <emir 9arpet. (e further assume that the ordering cost, #s$ is the cost of setting up the production process to ma"e <emir carpet. /ecall that !;2.K6.meter and 9; +2222 m.year.

The manufacturing facility operator the same days the store is open ,i.e. '++ days- and produces +62 m of the carpet per days. <etermine the optimal order si)e, total inventory cost, +6F

+N2

the length of the time to receive an order, the number of orders per year, and the maximum inventory level. #o ution s ; +62M@.order !;2.K6 per unit 9;+2222m c;+2222.'++ ;'4.4m.day Qo;
>,49s-.!,+ 8 c./-=

>,4-,+2 222-,+62-=.>2.K6,+ 8 '4.4.+62-=

; 4 46N.L m

This value is substituted into the following formula to determine total minimum inventory cost5 De; or De; ,9.Q2-.s C ,Q2.4-!,+8c./- ; ,+2222.446N.L-+62 C ,4 46N.L.4-,2.K6-,+8'4.4.+62; + '4F M@ The length of time to receive an order for this type of manufacturing operation is commonly called the length of the production run. It is computed as follows t+ ; Q2./ ; 4 46N.L.+62 ; +6.26 days.order The number of orders per year is actually the number of production runs that will be made 3o ; Q = 446N.L ; G.G' runs.year The maximum inventory level is. Imax; Qo,+8 c./- ; 446N.L ,+8'4.4.+62- ; + KK4 m Exa$p e &%: The manager of a bottling plant which bottles soft drin"s needs to decide how long a VrunV of each type of drin" to as" the lines to process. <emand for each type of drin" is reasonably constant at L2 222 per month ,a month has +N2 production hours-. The bottling lines fill at a rate of '222 bottles per hour but ta"e an hour to change over between different drin"s. The cost of each changeover ,cost of labor and lost production capacity- has been calculated at +22 M@.hour. 0toc"8holding costs are counted at 2.+ M@.bottle8month. a. How many bottles the companies produce an each runI
C +2222
49s!,+ 8 c./-

4,+2 222-,+62-,2.K6-,+ 8 '4.4.+62-

; + '4F M@

+N2

+N+

b. The staffs who operate the lines have devised a method of reducing the changeover time from + hour to '2 minutes. How would that change the !:0I #o ution: a. !:0; W49s.R!,+8c./-Q ; WR4XL2222X+22Q.R2.+,+8622.'222-Q ; +' L6N bottles b. 3ew s ; 62 3ew 12 ;W,4X62XL2222-.R2.+,+862.'222-Q ; F KFL bottles Exa$p e &&: Yantsan 9o. ma"es and sells specialty hubcaps for the retail automobile after mar"et. YantsanVs forecast for its hubcap is +222 units next year, with an average daily demand of G units. However, the production process is most efficient at L units per day ,so the company produces L per day but uses only G per day-. Uiven the following values, solve for the optimum number of units per order. #o ution: Jnnual demand ; 9; +222 units 0etup cost ; s; +2 M@ Holding cost ; !; 2.62 M@.unit8year <aily production rate ; /; L units.day <aily demand rate ; G units.day Q2 ; W49s.R!,+8c.s-Q ; W,4X+22X+2-.R2.6,+8G.L-Q ; 4L4.L ; Z 4L' hubcaps. Exa$p e &': &lemming Jccessories producers paper slicers used in offices and art stores. The minislicer has been one of its most popular items annual demand is NK62 units, and is constant throughout the year. Minislicers are produced in batches. Jn average the firm can manufacture +46 minislicers.day. <emand for these slicers during the production process is '2 day. The set8up cost for the e%uipment necassary to produce the minislicers is +62 M@. 9arrying costs are + M@.minislicers per yaer. How many minislicers should &lemming manufacture in each batchI #o ution: +N+

+N4

Q2 ; W49s.R!,+8c.s-Q ; W,4XNK62X+62-.R+,+8'2.+46-Q ; + N'4 minislicers.run Exa$p e &(: Yan Uetry is the owner of a small company that produces electric scissors use to cut fabric. The annual demand is for L222 scissors and Yan produces the scissors in batches. On the average, Yan produces +62 scissors per day and during the production process, demand for scissors has been about G2 scissors per day. The cost to set up the production process is +22 M@ and it costs Yan 2.'2 M@ to carry one pair of scissors for one year. How many scissors should Yan produce in each batchI #o ution: Q 2 ; W49s.R!,+8c./-Q ; W,4XL222X+22-.R2.',+ 8G2.+62-Q ; 4 NFK scissors .run

Quantity Discounts
Quantity discounts are price reductions for large orders offered to customers to induce them to buy in large %uantities. If %uantity discounts are offered, the customers must weigh the potential benefits of reduced purchase price and fewer orders that will result from buying in large %uantities against the increase in carrying costs caused by higher average inventories. The buyer*s goal with the %uantity that will minimi)e total cost, where the total cost is the sum of carrying cost, ordering cost, ordering cost and purchasing. D ; 9arrying 9ost C Ordering 9ost C Purchasing 9ost ; ,1.4-! C ,9.1-? C 9p In the basic !OQ model, determination of the order si)e does not involve the purchasing cost. The rationale for not including unit price is that under the assumption of no %uantity discounts, price per unit is the same for all order si)es. (hen %uantity discounts are offered, there is a separate @8shaped total8cost8curve for each unit price. !ach curve has a minimum those points are not necessarily feasible. The obMective of the %uantity discount model is to identify an order %uantity that will represent the lowest total cost for the entire set of curves. There are two general cases of the model. i. 9arrying costs are constant ,e.g. 4 M@.unitii. 9arrying costs are stated as a percentage of purchase price , e.g 42 7 of unit price(hen carrying costs are constant, there will be single !OQ, which is the same for all the cost curves.

+N4

+N'

Da Db Dc
x !a,b,c 4

C B X

&ig. G5 (hen carrying costs are constant, all curves have the same !OQ. (hen carrying costs are specified as a percentage of unit price, each curve will have a different !OQ. Ka Kb Kc

CCa CCb carrying cost EOQ EOQ a

b EOQ

&ig. 65 (hen carrying costs are giving as a percentage of unit prices. The procedure for determining the overall !OQ differs slightly depending on which of these two cases is relevant. J8 (hen carrying costs that are constant, the procedure is as follows5 +.9ompute the common !OQ. 4. Only one of the unit prices will have the !OQ in its feasible range since the range do not overlap. Identify that range.

+N'

+NG

a- If the feasible !OQ is on the lowest price range, that is the optimal order %uantity. b- If the !OQ is in any other range, compute the total cost for the !OQ and for the price brea"s of all lower unit costs. 9ompare the total cost is the optimal order %uantity. Exa$p e &): The maintenance department of a large hospital uses about L+N cases of li%uid cleanser annually. Ordering cost is +4M@, carrying costs are GM@.cases, and the price schedule is as follows5

Ran"e + to GF 62 to KF L2 to FF +22 or more

.rice 42 M@ +L +K +N

<etermine the optimal order %uantity and the total cost. #o ution: +. 9ompute the common !OQ ; 1o ;
,49?-.!

>4,L+N-,+4-=.G

; K2 cases

4. The K2 cases can be bought at +L M@.case, since K2 falls in the range of 628KF cases. The total cost to purchase L+N cases. a year at a rate of K2 cases.order, will be5 DK2 ; ,9.1- ? C ,1.4-! C 9p ; ,L+N.K2-+4 C ,K2.+4-G C L+N+L ; +G FNL M@ 0ince the cost ranges exist, each must be chec"ed against the minimum cost generated by K2 cases at +L M@ each. In order to buy at +KM@.case, at least L2 cases must be purchased. The total cost at L2 cases will be DL2 ; ,L+N.L2-+4 C ,L2.4-G C L+N+K ; +G +6G M@ To obtain a cost of +N M@ . case, at least +22 cases per order are re%uired, and the total cost will be D+22 ; ,L+N.+22-+4 C ,+22.4-G C L+N+N ; +' '6G M@ Therefore, since +22 cases per order yields the lowest total cost, +22 cases is the overall optimal order %uantity. ?. (hen carrying costs are expressed as a percentage of price, determine the best purchase %uantity with the following procedure5

+NG

+N6

+. ?eginning with the lowest price, compute the !OQ for each price range until a feasible !OQ is found ,i.e. until an !OQ is found that falls in the %uantity range for its price4. If the !OQ for the lowest price is feasible, it is the optimal order %uantity. If the !OQ is not the lowest price range, compare the total cost at the price brea" for all lower prices with the total cost of the largest feasible !OQ. The %uantity that yields the lowest total cost is the optimum. Exa$p e &*: (J Quantity <iscount with 9onstant 9arrying 9ost9omptech 9omputers wants to reduce a large stoc" of microcomputers it is discontinuing. It has offered the !astern Mediterranean @niversity ?oo"store at 3orthern 9yprus a %uantity discount pricing schedule if they will purchase the microcomputers in volume, as follows. Quantity Price +.GF.+.+ +G22M@ 62.LF.+.+ ++22 F2C F22 The annual carrying cost for the @niversity for a microcomputer is +F2 M@, the ordering cost is 4622 M@ and the annual demand for this particular model is estimated to be 422 units. The @niversity ?oo"store units to determine if it should ta"e advantage of this discount an order the basic !OQ order si)e. #o ution: &irst determine the !OQ and total cost with the basic model.. ?;4622M@ !;+F2M@ 9;422 units .year 12 ;
49?.!

>4,4622 422-=.+G2

; K4.6 ; K' 9omputers

Jlthough we will use 1o;K4.6 in the subse%uent computation, realistically the order si)e would be K' computers. This order si)e is eligible for the firs discount of ++22 M@. Therefore this price is used to compute total cost as follows5 T9;D ;,9.1-? C ,1.4-! C9p ; ,4622.4-422C,K4.6.4-+F2 C++22,422; 4''KLG M@ 0ince there is a discount for a large order si)e than 62, this total cost of 4''KLG M@ units must be compared with total cost with an order si)e of 62 and a price of F22 M@, as follows. D; ,4622.4-422 C ,F2.4-+F2 C F22,422- ; +FG+26 M@

+N6

+NN

0ince this total cost is lower ,+FG+26M@[4''KLGM@-, the maximum discount price should be ta"en and F2 units should be ordered. Exa$p e &+: J manufacturing firm has been offered a particular item it uses according to the following discount pricing schedule provided by the supplier. Quantity +.+FF 422.6FF N22C .rice N6M@ 6F 6N

The manufacturing company uses K22 of the items annually, the annually carrying cost is +GM@.unit, and the ordering cost is 4K6M@.<etermine the amount the firm should order. #o ution: &irst, determine the optimal ,economic- order si)e and the total cost with basic !OQ model. 12 ; De;
49?.! 49?!

; ;

>4,4K6-,K22-=.+G

4 4K6 K22 +G

; +N6.L' units ; 4 '4+.NG M@

3ext compare the order si)e with the second8level %uantity discount with an order si)e of 422 and a discount price of 6FM@. D; ,4K6.422-K22C ,+G.4-42 C6F,K22-; G' NN4.62 M@ This discount results in a lower cost. &inally, compare the current discounted order si)e with the fixed8price discount for 1;N22 D; ,K22.422-4K6 C ,N22.4-+G C 6N,K22-; G' K42.L' M@ 0ince this total cost is higher, the economic order is 422 with a total cost of G'NN4.62M@ Exa$p e ',: 0urge !lectric uses G222 toggle switches a year. 0witches are priced as follows5 Ran"e +8GFF 6228FFF +222C !nit .rice 2.F2 M@ 2.L6 2.L4 E/ 0p

+NN

+NK

It costs approximately +L M@ to prepare an order and receive it, and carrying costs are +L7 of the purchase price per unit on an annual basis. <etermine the optimal order %uantity and the annual cost. #o ution: Ran"e +8GFF 6228FFF +222C !nit .rice 2.F2 M@ 2.L6 2.L4 E / 0p 2.+L,2.F2-;2.+N42 2.+L,2.L6-;2.+6'2 2.+L,2.L4-;2.+GKN

a- &ind the !OQ for each price, starting with the lowest price, until a feasible !OQ is located, !OQ2.L4 ; 49?.! ; >4,G222 +L-=.2.+GKN ; FLL switches 0ince FLL switches will cost 2.L6 M@ each rather than 2.L4 each, FLL is not feasible !OQ. 3ext try 2.L6 per unit. !OQ2.L6 ;
>4, G222 +L-= . 2.+6'

; FK2 switches

This is feasible FK2 fall in the 2.L6 M@ ranges of 6228FFF. b- DFK2 ; ,G222.FK2- +L C ,FK2.4- 2.+6' C 2.L6,G222- ; ' 6GL M@ D+222 ; ,G222.+222- +L C ,+222.4- 2.+GKN C 2.L4,G222- ; ' G4N M@ Thus the minimum8cost order si)e is +222 switches. Exa$p e '-: (Quantity <iscount with 9arrying cost as a 7 of price.The I)mir 0agli" Hospital uses disposable surgical pac"ages for many routine operations rather than sterilising and pac"aging the necessary bandages and instrument. It uses approximately +22 0urgical Pac"ages unit each month. !lective surgery is scheduled for times when the schedule for other surgery is low, so that demand for 0urgical Pac"ages is fairly uniform. !ach 0urgical Pac"ages costs '6M@ in %uantities of less than K6, and '4,62 if purchased in %uantities of K6 or more. The hospital estimates that it costs LM@ to process and receive an order. The cost of holding ,carrying- inventory is estimated to the +47 of the purchase per year. <etermine the economic order %uantity and the total cost. #o ution: Ran"e +8K6 K6C !nit .rice '6M@ '4.62M@ E/01p2222222222 '6,2.+4- ; G.4 '4.6,2.+4- ; '.F

a- &ind the !OQ for the each price, starting with the lowest price, until a feasible !OQ is located. 1'4.62 ;
,49?-.,Ap-

>4,+422 L-=.,'.F-

; K2 units

+NK

+NL

This %uantity is not feasible. The hospital would not receive the lowest price if it purchased K2 pac"ages each time. 3ext try '6 M@ per unit. 1'6 ;
,49?-.,Ap-

>4,+422 L-=.,G.4-

; NK.N+ ; NL units

This is a feasible order %uantity, but another step will determine of it is the best. The hospital will achieve a si)eable saving on the item cost if it purchases K6 units in each order. :ets use Total 9ost e%uation to evaluate this possibility and find the total annual cost if NL is used as the order %uantity. DNL ; be DK6 ; ,K6.4-'.F2 C ,+422.K6-L C +422,'4.6- ; 'F 4KG.46 M@ The proper order %uantity is K6 surg pac"s.
49?!

C 9p ;

4,+422 L G.4-

C +422,'6- ; G4 4L'.FK M@

If the hospital buys the 0urgical Pac"ages in %uantities of K6 the total annual cost will

Exa$p e '2: J small manufacturing firm uses roughly 'G22 "g. of chemical dye a year. 9urrently the firm purchases '22 "gs per order and pays 'M@."g. The supplier has Must announced that orders of +222"gs. or more will be filled at a price of 4 M@."g. The manufacturing firm incurs a cost of +22 M@ each time it submits an order and assign an annual holding cost of +K7 of the purchase price per "g. a. <etermine the order si)e that will minimise the total cost. b. If the supplier offered the discount at +622 "g instead of +222 "g*s, what order si)e would minimise total costI #o ution: a9 ; 'G22"g.year p;4 ! ; Ap ; 4,2.+K- ; 2.'G 1 4M@."g ;
49?.!

4,'G22x+22-.2.'G

; + G+G "gs

0ince the %uantity is feasible at 4M@."g it is the optimum. b(hen the discount is offered at +622 "gs, the !OQ for the 4 M@."g range is no longer feasible. 9onse%uently it becomes necessary to compute the !OQ for ' M@."g and compare the total cost for that si)e with the total cost using the price brea" %uantity ,i.e +622-. 1 'M@."g ;
49?.!

>4,'G22 +22-=.,2.+K '-

; + +66 "gs +NL

+NF

D ++66 ; ,'G22.++66-+22 C ,++66.4-,2.+K-,'- C 'G22,'- ; +2 KLF M@ D +622 ; ,'G22.+622-+22 C ,+622.4-,2.+K-,4- C 'G22,4- ; K 4L4 M@ Hence, because it would result in a lower total cost, +622 is the optimal order si)e.

3ow to Deter$ine the Opti$u$ #a4ety #toc5 Le6e when Out-o4-#toc5 7osts are 8nown
How much should we buy when it is time to replenish the inventoryI This %uestion was answered through Model + and 4. Here we want to introduce %uantitative techni%ues that will help us to answer the %uestion5 When should we replenish the inventory? This when8 to8order point is called the #Reorder Point$.

Lead 9i$e If you call for home delivery of pi))a and it ta"es 4 hrs for it to arrive, then 4 hrs. is the lead-time. If you order is going to be delivered '2 calendar days after, then '2 days is the lead8time. @sage of an item during lead8time is "nown as lead-time demand.
inventory level

EOQ

reorder level

time leadtime

order received order placed &ig. N5 Inventory level with constant demand and constant lead8time. The assumptions +- 9onstant demand 4- 9onstant lead8time are hardly ever true. Planned demand of an item can be affected by

+NF

+K2

8@nexpected mar"et acceptance. 8?y the weather or 8 ?y a stri"e. The lead8time varies too 8 J supplier may run into problems ,stri"es, floods, brea" downsor 8 The transportation company may experience delays. \ariations in the lead8time or in demand often cause stock-outs, the condition that exists when the inventory on the hand is not sufficient to cover needs.

reorder
inventory level

order placed point

late arrival
normal lead time

order received

stockout

3ote that inventory level does not increase to original points, since unfilled orders have to be filled. ,(e are assuming here that the customer waits for delivery and does not cancel the order-

a- Inventory level with constant demand and excessively long lead time. order received
inventory level order placed

reorder point level stockout

normal leadtime

+K2

+K+

b- Inventory level with excessive demand and constant lead8time. &ig.K5 Inventory levels. 0toc"8outs are undesirable because they can be %uiet expensive. :ost sales and disgruntled customers are examples of external costs. Idle machines and employee ill will are examples of internal costs. Management desire to avoid stoc"8outs leads to further consideration of when to order and reorder.

#a4ety #toc5
0afety8stoc"s constitute one of the maMor means of dealing with the uncertainties associated with variations in demand and lead8time. Safety-stocks are amounts of inventory held in excess of regular usage %uantities in order to provide specified levels of protection against stoc"8out. Safety-stocks are extra inventory held as a badge, or protection against the possibility of a stoc"8out. It is obvious that a safety stoc" has two effects on a firm*s costs. It will decrease the cost of stoc"8outs, but increase carrying costs. The cost of stoc"8out multiplied by the number of stoc"8outs prevented by the safety stoc" gives the cost reduction figure. 3ote that this cost addition is continuing 8even permanent8 in nature because the safety stoc" is always a part of total inventory. 3ote that also because the safety stoc" does not often define in %uantity, we do not divide it by 4 to get average inventory. Exa$p e '%: J nationwide truc"ing firm has an average demand of +2 new tires per wee" and receives deliveries from a I)mit tire company about 42 business days ,6 days.wee"- after placing an order. If the firm see"s to maintain a safety stoc" of +6 tires, what is the order pointI #o ution: Order point ,OP- ; clt C00 ; ,+2 tires.wee"-,G wee"s- C +6 tires ; 66 tires Exa$p e '&: J producer of U]l 0hampoo uses G22 litres per wee" of a chemical, which is ordered in !OQ of 6222 litres at a %uantity discount cost of '.K6 M@.litre. The procurement lead8time is maintained. The storage cost is 2.2+ M@.litre8wee". &ind a- The maximum inventory on hand. b- The average inventory maintained. c- The order point in units. #o ution:

+K+

+K4

a- Maximum Inventory ; I max ; 0afety 0toc" C !OQ I max ; 422 C6222 ; 6422 litres b- Jverage Inventory ; Iave; ,Imax C Imin-.4 ; ,6422 C 422-.4 ; 4 K22 liters c- Order point ; OP ; c lt C 00 ; G22 x 4 C 422 ; + 222 litres The optimum safety stoc" to carry is determined in the light of two goals, which are somewhat hostile to each other5 +- to minimise the cost of stoc"8outs while also 4- to minimise carrying costs on the safety stoc". The decision of how much safety stoc" to carry is not an easy one. !very approach to this problem has its own limitations. To determine an approach level of safety stoc", we will use the probability approach, the most satisfactory approach. 8(e shall assume a constant lead8time 8(e shall assume that each lot is delivered all at one time. @nder these assumptions, a stoc"8out can be caused only by an increase in demand after the reorder point has been reached. If the increase had occurred before the reorder point was reached, a purchase order would have been placed at the moment the inventory. Exa$p e '': The cost of being out of stoc" for a particular item ; 62 M@.unit 9u cost of carrying one item in safety stoc" ; +2 M@ . unit. !OQ ; 'N22 units average daily usage ; 62 items.day. 3o; 6 orders :ead8time ; N days Inventory record card is given in the following table. How much safety stoc" the firm should carryI !se durin" reorder .eriod: units +62 422 462 '22 '62 G22 G62 #o ution: ;o1 o4 ti$es this <uantity was used ' G N NL F K ' -,, !se pro=a=i ity '.+22 ;2.2' G.+22;2.2G N.+22;2.2N NL.+22;2.NL F.+22;2.2F K.+22;2.2K '.+22;2.2' -1,,

+K4

+K'

Order point ; :ead time x @sage.day; N days x 62 units.day ; '22 units Ordering point is '22 units. The company will be safe L+7 of the time ,2.NL C 2.2N 2.2G C2.2'-, but it will be out of stoc" +F7 of the time ,2.2F C2.2K C2.2'- . (e are concerned over this figure of +F 7. To reduce or avoid this shortage, we could carry some safety stoc" and pic" the one, which yields the lowest total for +. 9ost of stoc"8outs plus 4. 9arrying costs on the safety stoc". Thus we would consider carrying a safety stoc" of5 i. ', !nits This would cover a usage of '62 during the reorder point. (e would be out of stoc" only when usage is G22 or G62 units. ,2.2K C2.2' ; 2.+2 of the timeii. -,, !nits This would cover a usage of '62 or G22 units during the reorder point. (e would be out of stoc" only when usage is G62 units. This would be 2.2' of the time. iii1 -', !nits This would cover a usage of '62,G22 or G62 during the reorder point. (e would never run out of stoc" with this amount of safety stoc". If the optimal order number is 6 orders per year, the firm, therefore, be in danger of running out of item 6 times during the year. !OQ thus affects the reorder point. The cost of being out of stoc" for the four courses of action 8 3o safety stoc" 8 62 units 8 +22 units 8 +62 units are shown in the table.

#a4ety stoc5

.ro=1 O4 =ein" out

;o1 short

Expected annua cost shorta"e 62x2.2F x62M@x+ 6 ;++46 +22x2.2K x62M@x6 ;+K62

9ota annua cost

>nnua carryin" cost

9ota cost?year (stoc5out @ carryin")

2.2F when we use is '62 2.2K when we use is G22

62

+22

+K'

+KG

2.2' when we use is G62 62 2.2K when we use is G22 2.2' when we use is G62 2.2' when we use is G62 2

+62

62 +22

+62x2.2' x62 M@x6 ;++46 62x2.2K x62M@x6 ;LK6 +22x2.2' x62M@x6 ;K62 62x2.2' x62M@x6 ;'K6

G222

G222M@

+N46

62x+2M@ ;622M@ +22 x+2M@ ;+222 +62x+2M @ ;+622

4+46M@

+22 +62

62 2

+'K6M@ +622M@

The appropriate safety stoc" is +22 units. Jdoption of the safety stoc" policy would change the reorder point. If +22 motors are held as safety stoc", then the reorder point is determined as follows. /eorder point ; average daily use x lead time C 0afety 0toc" ; 62 x N C +22 ; G22 units Exa$p e '(: <emir 0ales has used a fixed8%uantity model as a basis for establishing its inventory policy for the past three years. <uring the time the sales pattern has been fluctuating. In such a way that demand remains uncertain. &or the past year, <emir 0ales manager has "ept a record of actual demand during the reorder period. The results are shown in Table below.

!se durin" reorder period (units) 62 +22 +62 422 462 '22 '62

Fre<uency o4 use G F +4 G6 +4 L N -,,

Re ati6e 4re<uency o4 use G.+22 F.+22 +4.+22 GF.+22 +4.+22 L.+22 N.+22 -,,?-,,

.ro=a=i ity o4 use 2.2G 2.2F 2.+4 2.GF 2.+4 2.2L 2.2N -1,,

7u$u ati6e pro=a=i ity tota s 2.2G 2.+' 2.46 2.KG 2.LN 2.FG +.22

+KG

+K6

9urrent reorder point for <emir 0ales is 422 units, a policy, which involves no stoc"8 out KG 7 of the time. If 62 units to 462 units increase the reorder point then the management will be the safe 4N 7 of the time. 0uppose <emir 0ales wants to "now the total annual cost of various safety stoc" possibilities. The cost of running out of stoc" is set at +2 M@.unit. 9alculate these potential costs when the reorder point is 422 units and the company orders N times per year R0hortage cost is +2 M@.unitQ #o ution: /eorder pt. ,preset- ; 422 units @sage above reorder level ; 462,'22,'62 @sage probabilities ; 2.+4,2.2L,2.2N 0hortage cost ; +2 M@.unit. Orders per year ; N #a4ety stoc5 !sa"e !nits short
.ro=a=i it y o4 shorta"e

>nnua 7ost
(-,Mux(x units short)

Expected >nnua 7ost 'N2 GL2 6G2 4G2 'N2 +L2 2

9ota Expected >nnua 7ost

62 +22 +62

462 '22 '62 '22 '62 '62 '62

62 +22 +62 62 +22 62 2

2.+4 2.2L 2.2N 2.2L 2.2N 2.2N 2

'222 N222 F222 '222 N222 '222 2

+'L2 N22 +L2 2

0afety stoc" of o units results in a total expected annual cost of +'L2 M@, and a safety stoc" of 62 units yields cost of N22 M@ and +22 units safety stoc"s has total cost of +L2 M@. J safety stoc" of +62 units yields M@. If the management of <emir 0ales were to institute a safety stoc" policy that would minimi)e the total expected annual cost, the policy would re%uire a safety stoc" of +62 units.

#er6ice Le6e
Js told before when variability is present in demand or lead8time, the possibility that actual demand will exceed expected demand is created. 0afety stoc" will reduce the ris" of running out of inventory ,a stoc"8out- during lead8time. The reorder point then increases by the amount of safety stoc"5

+K6

+KN

Order point ,OP- ; clt C 00 0toc"8out protection is needed only during lead8time.?ecause it costs a lot of money to hold safety stoc", a manager must carefully weight the cost of carrying safety stoc"8out against the reduction in stoc"8out ris" it provides, since the service level increases as the ris" of stoc"8out decreases. Order cycle service level can be defined as " The probability that demand will not ex eed supply durin! lead time""i.e that the amount o# sto $ on hand will be su##i ient to meet demand% Hence, 0ervice level of F67 implies a probability of F67 that demand will not exceed supply during lead8time. Jn e%uivalent statement that demand will be satisfied in F67 of such instances does not mean that F67 of demand will be satisfied. The ris" of stoc"8out is the complement of service level stoc"8out ris" is 67. 0ervice models can be used when demand variability is present. The first model can be used if an estimate of expected demand during lead8time and its standard deviation are available.

risk of stockout

Service level
(probability of no stockout)

Q
expected demand S!"E#$ S#OCKS

OP
% scale

&ig. L5 The OP based on a normal distribution of lead8time demand. The formula is O. / Expected De$and durin" ead ti$e @ 0 7 t The models generally assume that any variability in demand rate or lead8time can be ade%uately described by a normal distribution. The value of #A$ depends on the stoc"8out ris" that the manager is willing to accept generally, the smaller the ris" the manager is willing to accept, the greater the value of A. The value of A is obtained from normal distribution table. Exa$p e '):

+KN

+KK

0uppose that the manager of a construction supply house determined from the historical records that the lead8time demand for sand average 62 tons. In addition, suppose the manager determined that demand during lead8time could be described by a normal distribution that has a mean of 62 tons and a standard deviation of 62 tons. Jnswer these %uestions, assuming that the manager is willing to accept a stoc"8out ris" of no more than '7. a. (hat value of ^A ^ is appropriateI b. How much safety stoc" should be heldI c. (hat reorder point should be usedI #o ution: !xpected lead time demand ; 62 tons clt ; 6 tons /is" ; '7 a. &rom the normal8distribution table, using a service level of + 8 2.2' ; 2.FK , you obtain a value of A ; C +.LL b. 0afety 0toc" ; A clt ; +.LL,6- ; F.G2 tons c. OP ; c lt C A clt ; 62 C F.G2 ; 6F.G2 tons (hen data on lead8time demand are not readily available the above formula cannot be used. 3evertheless, data are generally available on daily or wee"ly demand, and on the length of lead8time. @sing that data, a manager can determine whether demand and .or lead time variable and if variability exists in one or both, the related standard deviation,s-. &or those situations the following formulas can be used. X If only demand is variable, then #clt ; OP ; c :T where
:T c # and the reorder point is

c ; average daily or wee"ly demand :T; lead time in days or wee"s.

X If only lead8time is variable, then clt ; clt , the order point is OP ; c:T C Aclt X If both demand and lead8time are variable, then OP ; c :T C A :T 4 + Exa$p e '*: J restaurant use an average of 62 Mars a special sauce each wee". (ee"ly usage of sauce has a standard deviation of ' Mars. The manager is willing to accept no more than a +27 ris" of stoc" out during lead8time, which is two wee"s. Jssume the distribution of usage is normal. a. (hich are the above formulas is appropriate for this situationI (hyI b. <etermine the value of ) c. <etermine the reader point. +KK
4 4 lt

+KL

#o ution: c ; 62 Mars.wee" c ; ' Mars.wee" :T ; 4 wee"s /is" ; +27, 0ervice :evel ; F27 a- ?ecause only demand is variable ,i.e. has a std. dev.-. &ormula c:T C A :T c is appropriate. b- 0: ; F27 A ; C+.4L

c- OP ; c:T C A :T c ; 62 4 C +.4L 4 ' ; +22 C 6.G' ; +26.G' Mars Exa$p e '+: ,OP for variable demand and constant lead8timeThe house"eeping department of a motel uses approximately G22 washcloths per day. The actual amount tends to vary with the number of guest or any given night. @sage can be approximated by a normal distribution that has a mean of G22 a std. deviation of F washcloths per day. J linen supply company delivery towels and washes cloths with a lead8time of ' days. If the motel policy is to maintain a stoc"8out ris" of 47, what is the minimum number of washcloths that must be on hand at reorder time, and how much of that amount can be considered safety stoc"I #o ution: c ; G22 washcloths.day :T ; ' days c ; F washcloths.day /is" ; 47 0: ; FL7 A for FL7 is about C 4.266 OP ; c:T C A :T c ; G22,'- C 4.266 ' F ; +422 C '4.2' ; +4'4 washcloths

0afety 0toc" ; '4 wash cloths Exa$p e (,: (OP for constant demand and variable lead timeThe motel uses approximately N22 bars of soap each day and this tens to vary more than a few bars either way. :ead8time for soap delivery is normally distributed with a mean of N days and a standard deviation of 4 days. J service level of F27 is re%uired. &ind the reorder point. #o ution: c ; N22 bars.day 0: ; F27 A ; C+.4L :T ; N days lt ; 4 days

S&'()*

+,))

-.+,

+KL

+KF

OP ; c :T C A c ,lt; N22,N-C+.4L,N22-,4; 6+'N bars of soap

Exa$p e (-: ,OP for variable demand rate and variable lead timeThe motel replaces bro"en glasses at a rate of 46 per day. In the past, this %uantity has tended to vary normally and have a standard deviation of ' glasses.day. Ulasses are ordered from E)mir supplier. :ead time is normally distributed with an average of +2 days and a standard deviation of 4 days. (hat reorder point should be used to achieve level of F67I #o ution: c ; 46 glasses.day 0: ;F67 ) ; +.N6
4 4 lt

:T ; +2 days

c ; ' glasses.day

lt ; 4 days

4 OP ; c:T C A :T + ; ''G glasses

; 46,+2- C +.N6

+2,'- 4 +,46- 4 ,4- 4

MODEL III : In6entory Mana"e$ent with . anned #toc5-outs (Aac5-order Mode )

@p to this we have been concerned with methods which prevent stoc"8outs. However, in certain situations management may find it desirable from a cost point of view to not only allow stoc"8out but to plan for them. It is %uite common, for example, not to find the sofa you want in the fabric you want at your local furniture store. The shop"eeper will, however, order exactly what you want if you will wait for delivery.

Aac5-orders
The specific type of stoc"8out we are concerned with here is called a # back-order$. (hen we spea" of an item being bac"8ordered, we imply that5 +. The customer placed an order. 4. The supplier was out of stoc" in that item. '. The customer does not withdraw the order. G. The customer waits until the next shipment arrives. 6. The supplier fills the customer*s order when the next shipment arrives

+KF

+L2

If however, the customer will withdraw the order when the item is found to be out of stoc", the bac"8order model is not appropriate. In bac"8order model, we will have the additional #cost of back-ordering$. ?ac"8ordering cost is composed of two different costs. +. Jny cost of handling the bac"order ,special handling, follow8up, labour4. (hatever loss of customer goodwill occurs as a result of having to bac"order an item. Management scientists have determined that the optimum units per economic lot si)e , 12and number of units bac"8ordered ,0- ,owed to customers when a new economic lot arrivesand also Imax, i.e. maximum inventory level possible when economic lot arrives. x) inventory level 0 max

s'no/ of units backordered

1 2 #
complete inventory cycle

#ime S k t. ts
time during 34ic 4 t4ere is a stockout time during 34ic4 inventory is available

&ig. F5 Inventory behaviour in bac"8order situation For$u as: !conomic Order Quantity 0toc"8out Quantity Total Inventory 9osts V 5 5 5 5 5 0toc"8out time 5 Time inventory available 5 9omplete Inventory 9ycle Time5 Maximum Inventory 5 5 12 ; ,49?.!- 0 ; 12 ,!.,!Cd-0 ;
,! +d-.d

or

0 ; De.d

,49?.d-

d.,! +d-

De ; >,1280-4.412=! C,9.12-? C,04.412-d De ; 49?! d.,! +dt0 ; 0.c ,c ; daily demand rate t+ ; ,12 8 0-.c T2 ; 12.c Imax; 1o,d.,!Cd-Imax; ,49?.!- d.,! +d-

Exa$p e (2:

+L2

+L+

Mr. Jhmet <o_ru is the /enault dealer in E)mir. Jfter having explained the bac" order model to him, he believes that his situation is one for which the assumptions of this model hold true. Mr. <o_ru has come up with these estimates5 9 ,annual demand- ; G22 units ! ,annual carrying cost for inventory expressed as M@.unit.year- ; L22 M@ ? ,cost per order- ; +22 M@ d ,cost to maintain + unit on bac" order status for + year- ; +62 M@ a- 9omplete the optimum 1O and 0. b- 9omplete the total annual cost of inventory system.

#o ution: a12 ;
,49?.!- ,! +d-.d

>4,G22-,+22-=.L22

,L22 ++62-.+62

; 46 cars 0 ; 46.+NN ,L22.,L22C+62-- ; 4+.+F ; 4+ cars as bac"8order Mr. <o_ru would plan to have 4+ cars bac"8ordered at the time each shipment of 46 cars, the economic lot, arrived. c- Total annual inventory cost with 1O ; 46 cars and bac"8orders ; 4+ cars De ;
,49?.!- d.,! +d-

4,G22-,+22-,L22-

+62.,L22 ++62-

; ' +KL.LL M@

MODEL IB1 In6entory Mana"e$ent Cith . anned #toc5-outs (;o Aac5-orders)

In manufacturing organisations, stoc"8outs can halt production, idling expensive labour and facilities, other costs of being out of stoc" include the cost of expediting replacement inventory the cost of a loss of sales and a loss of goodwill and other intangible costs. The stoc"8out costs could be included in the !OQ and this would increase the order %uantity, which also decreases the fre%uency of exposure to the ris" ,cost- of the stoc"8out. :et d ; cost of stoc"8out !OQ ,(ith stoc"8out- ; 10O ;
>49,? +d-=.!

+L+

+L4

(e can use carrying costs to imply something about #d$ Implied d.order ; ,9arrying cost.year-.,orders.yeard.order ; R,12.4-!Q.32 (e assume that the firm is willing to carry inventory up to the point where this carrying cost is Must offset by the stoc"8out cost, i.e. same cost .order can be used as estimate of #d$. Exa$p e (%: J glassware manufacturer with an annual demand of 622 unit has ordering costs of G6 M@.order and carrying costs of +6M@.m Byear ab9ompute the implied stoc"8out cost. 9ompute revised !OQ with stoc" out costs.

#o ution: a. 1O;
49?.!

R4,G6-,622-Q.+6

; 66 units

Orders.yr. ; 9.12 ; 622.66 ; F orders Implied 0O cost.order ; d ; R,12.4-!Q.32 ; R,66.4-+6Q.F ; GN M@.order b. !OQ ,with 0O- ; Exa$p e (&: J firm has an annual demand of +222 units, ordering cost of +2M@.order and carrying cost of +2M@.unitByear. 0toc"8out costs are estimated to be about G2M@ each time when the firm has an exposure to stoc"8out. How much safety stoc" is Mustified by the carrying costsI #o ution: 1O;
>49,? + <-=.! >49,? +d-=.!

>4,622-,G6 +GN-=.+6

; KL units

>4,+222-,+2 +G2-=.+2

; +22 units

Orders .yr ; 9.12 ; +222.+22 ; +2 orders.year 0toc"8out costs ; G2M@ +2 orders ; G22M@.year Jt carrying cost of +2 M@.unitByear, the G22M@ will fund ,G22 M@.year-.,+2 M@.unit8year- ; G2 units of safety stoc"s

+L4

+L'

#OLBED .ROALEM#
Exa$p e -: J contractor has to supply +2.222 bearings per day to an automobile manufacture. He finds that, when he starts a production run, he can produce 46.222 bearings per day. The cost of holding a bearing in stoc" for one year is 2.24 M@ and the set up cost of a production run is +L.22 M@. How fre%uently should production runs be madeI #o ution: (e assume that run si)es are constant, that a new run will be started whenever the inventory is )ero and that the sole reason for producing for inventory is to obtain lower production costs. Q2 ;
,49s-.>!,+ 8 c./-= ; >4,+L-,+2222-=.>,2.24.'N6-,+ 8 +2.46-= ;+26

222 bearings

t2 ; Q2.9 ; ,+26 222 bearings.day- . ,+2 222 bearings.day- ; +2.6 days Exa$p e 2: J subcontractor underta"es to supply diesel engines to a truc" manufacturer at the rate of 46 per day. There is a clause in the contract penalising him +2 M@ .engine .day late for missing the scheduled delivery date. The finds that the cost of holding a completed engine in stoc" is +N M@.month. His production process is such that each month ,'2 days- he starts batches of engines throw the shops, and all these engines are available for delivery any time after the end of the month (hat should his inventory level be at the beginning of each monthI ,i.e. immediately after ta"ing into stoc" the engines made in the previous month and then shipping engines to fill unsatisfied demand from the previous month.#o ution: In this problem we are concerned with balancing the costs of holding inventory against the costs of delayed deliveries to customer. 0ince the subcontractor has already decided to produce a batch of engines every month, he has fixed the si)e of each batch at 46 x '2 ; K62 engines. Imax ; 1O,d.,!Cd-- ; '2,46- R+2.,,+N.+2-C+2-Q ; K+4 engines Exa$p e %: J contractor underta"es to supply diesel engines to a truc" manufacturer at a rate of 46 per day. He finds that the cost of holding a completed engine in stoc" is+N M@ per month, and there is a clause in the contract penalising him +2 M@.engine .day late for missing the scheduled delivery date. Production of engines is in batches, and each time anew batch is +L'

+LG

started there are set8up costs of +2.222 M@. How fre%uently should batches be started and what should be the initial inventory level at the time each batch is completedI #o ution: ! ; +N.'2 M@.day 1O ; d ; +2 M@.day ; s ; +2 222 M@ c ; 46 engines.day
,+N.'2 ++2-.+2

,49?.!- d.,! +d-

>4,46-,+2 222-=.,+N.'2-

; FNL.4G6L ,+.24N'4- ; FF'.K' !ngines 0 ; 1oR!.,!Cd-Q ; FF'.K' R+N.'2.,+N.'2 C +2-Q ; 62.'+ !ngines

Imax ; 1O Rd.,!Cd-Q ; FF'.K' R +2.,+N.'2 C +2-Q ; FG'.G4 !ngines t2 ; 1o.9 ; FF'.K'.46 ; 'F.K6 ; G2 days It would be better to start a new batch approximately every G2 days. Thus the cost of inventory will be De; 49?! ; 62'.+M@ or De ; 0d. ; 62.'+ +2 ; 62'.+ M@ Exa$p e &5 J?98:ite, a manufacturing concern produces electric appliances. The company expects next years sales to be +L2 222 units. !ach run re%uires an outlay of +22 M@ for machine set8up and each unit carried inventory costs F M@. It is estimated that the cost of permitting a bac" order is +N M@. @nit.yr. !ach bac"8 order is filled as soon as the production run is completed. <etermine5 a- The optimal si)e for each production run, b- The maximum level of inventory that the manufacturer can expect to have on hand, c- The time between runs.
d.,! +d-

,4-,46-,+2222-,+N.'2-

+2.,+N.'2 + +2-

#o ution: a- Qo ;
49s.!

,! +d-.d

R4,+L2 222-,+22-Q.F

,F ++N-.+N

; 4 622 units

b- Imax; Q2Rd.,!Cd-Q ; 4 622 R +N.,FC+N-Q ;4 622 ,2.NG- + N22 units

+LG

+L6

c- to ; Q2.9 ; 4 622.+L2 222 ; 2.2+G year ; 6 days Exa$p e ': Jn Operations Management of 3ationwide 9ar Pentals must decide on the number of vehcles of a certain model to alocate to his agency in the U])elyurt area on a one8time basis. The cars are obtained from an auto leasing firm at a cost of 42 M@.day. 3aionwide rents the cars to its customers for '2 M@.day. If a car is not used, the auto leasing firm will give nationwide an L M@ rebate. /ecords of past demand have yielded the empirical probability distribution shown. How many units of this model should 3ationwide stoc" if it see"s to balance the costs of overstoc"ing and understoc"ingI Demand (# of cars) Prob. of demand P(C ) Cumulative prob. Of demand P(C ) , (or less) )/)) . 5 )/)+ . 6 )/)5 )/(5 ( )/.)/() .) )/7) )/5.. )/7+ )/-.7 )/.)/+7 .+ )/.7 )/.5 .8 )/))/).- (or more) )/)) )/)) #o ution: If the 3ationwide overstoc"s the loss.unit for every excess unit at the end of the period will be D2 ; 9ost.unit B 0\.unit ; 42 M@.unit B L M@.unit ; +4 M@.unit If the 3ationwide under stoc"s, the opportunity cost for every unit 3ationwide could gain, but did not stoc" will be Du ; Price.unit 8 9ost.unit ; '2 M@.unit B 42 M@.unit ; +2 M@.unit Then the critical probability is P,c - ; D2. D2 C Du ; +4 . +4C +2 ; 2.6G6 (e chose to stoc" ++ cars because our calculated P,9 - value of 2.6G6 is closer o cumulative probability of 2.66. (e would be inclined to stoc" less rather than more because the cost of overstoc"ing ,+4 M@- is `the cost of under stoc"ing ,+2 M@0O/ ; 2.6G6

+L6

+LN

?ecause the 0O/ is the complement of service level 0: ; +227 8 0O/7 0:; + B 2.6G6 ; 2.G66 0ervice level would be G6.67 Exa$p e (: <!MI/ 0PO/T0(!J/ can purchase a special shipment of wool caps for +.L6 M@ each. The caps can be sold for G.F6 M@ during the fall season, but any that have not been sold by 3!( O!J/ will be reduced to +.62 M@. The following probability distribution has been estimated for demand for these caps prior to 3ew Oear. 9aps must be purchased in do)ens. Jssume that any caps unsold by new year can be sold at the lower price. How many caps should <!MI/ purchaseI Demand (Dozens) 8 , 5 6 ( .) #o ution: If the store overstoc"s, the loss per unit for every excess unit at the end of the year will be D2 ; 9ost.unit B 0\.unit ; +.L6 M@.unit B +.62 M@.unit ; 2.'6 M@.unit If the store understoc"s, the opportunity cost for every unit the store could sell but did not stoc" will be Du ; Price.unit 8 9ost.unit ; G.F6 M@.unit B +.L6 M@.unit ; '.+2 M@.unit The critical probability P,c - ; D2. D2 C Du ; 2.'6 . 2.'6 C '.+2 ; 2.+2+ <!MI/ 0PO/T0(!J/ must purchase F do)ens because F do)ens of caps has a cumulative probability of 2.+6 which is `critical probability ,2.+2+Prob. That demand will equal this amount )/))/.)/7)/7)/.)/.) )/)Prob. That demand will equal or e ceed this level . )/()/6) )/-)/+) )/.)/)-

+LN

+LK

Exa$p e ): Hot cup cafe is faced with the decision of how many cups of coffee to prepare before a football game at the local stadium. !ach cup of coffee costs 2.2' M@ per cup and sells for 2.+4 M@ per cup. Past records indicate that 'L222 cups are enough to prevent any shortage and this is the number prepared before each game. @nsold coffee is disposed of at a total loss. The following data summari)es the sales history a. How many cups of coffee should be prepared prior to each gameI b. (hat is the long8run expected loss under the current policyI Demand 75))) 76))) 7())) +)))) +.))) +7))) ++))) +8))) +-))) #o ution: D2 ; 9ost.unit B 0\.unit ; 2.+4 M@.unit B 2.2' M@.unit ; 2.2F M@.unit Du ; Price.unit 8 9ost.unit ; 2.2' M@.unit B 2.22 M@.unit ; 2.2' M@.unit P,c - ; D2. D2 C Du ; 2.2' . 2.2' C 2.2F ; 2.46 Demand 75))) 76))) 7())) +)))) +.))) +7))) ++))) +8))) +-))) +,))) #elative probabilit" )/)5 )/.7 )/7) )/7)/.)/.) )/))/))/). )/)) Prob. (at demanded) least . )/(+ )/6. )/,. )/+, )/7. )/.. )/), )/). )/)) $%& units !requenc" 5 .7 7) 7..) .

The critical fractile is 2.46. This value is brac"eted by 2.'N and 2.4+, these values correspond to inventory levels of '+222 and '4222 respectively. 0elect as the optimal inventory level of two levels. The optimal inventory level is '+222 units.

+LK

+LL

b- To determine the long8run expected loss under the current policy, the difference between this cost and the cost of the optimal policy is the long8run expected loss. X The cost of the current policy ; 'L222X2.2' ; ++G2 M@ X The cost of the optimal policy ; '+222X2.2' ; F'2 M@ Thus the long8run expected loss ; ++G2 B F'2 ; 4+2 M@. Exa$p e *: The 9ity 9hronicle has a daily newspaper demand that varies from between 42222 and 4G222 copies per day. The paper costs 2.2L M@ per issue to produce and generates revenue of 2.42 M@ per issue. @nsold papers have no value. a. (hat is the optimal level of papers to stoc"I b. (hat service level would that optimal level corresponds withI #o ution: Du.P, 9-X ; DoRI 8 P, 9-Q P, 9-X ; Do.DoCDu (here, D2 ; 9ost.unit B 0\.unit; 2.2L B 2 ; 2.2L Du ; Price.unit 8 9ost.unit ; 2.42 B 2.2L ; 2.+4 P, 9-X ; Do.DoCDu ; 2.2L .2.2L C 2.+4 ; 2.G2 The 2.G2 is the e%uating probability that demand will be exceeded and represents a stoc" out ris" established on the basis of the basis of costs given. Thus the corresponding 0!/\E9! :!\!: is 0ervice level ; + B 0toc" out ris" 0: ; +82.G2 ; 2.N2 Iopt ; 9 min C 7 0: ,inventoryIopt ; 42222 C 2.N ,4G222 B 42222- ; 44G22 units.

Exa$p e +:

+LL

+LF

?M( Juto sales is offering a special car attachment at the unheard8of8price +22 M@.unit. The attachment costs M3( K2 M@. @nsold units can be salvaged for '2 M@.unit. Management has proMected the following wee"ly demand pattern5

Cee5 y de$and (units) '6 'N 'K 'L 'F G2 G+C

.ro=a=i ity o4 de$and 2.+2 2.+6 2.46 2.46 2.+6 2.+2 2 +.22

a. @sing marginal analysis, determine the otimal stoc" level b. 0uppose that restoc"ing is a continual process. If the unit is not sold in one period, it is held over the next period. However, there is an additional cost of +6 M@ for handling and storage. (hat is the optimal stoc" level under these conditionsI ,@se marginal analysis and assume that any unsold unit is held over for one period only#o ution: a. 0elling price.unit ; +22 M@ 9ost.unit ; K2M@ 0alvage value .unit ; '2 M@ D2 ; 9ost.unit B 0\.unit; K2 B '2 ; G2 M@ ,marginal lossDu ; Price.unit 8 9ost.unit ; +22 B K2 ; '2 M@ ,marginal profitP, 9-X ; Do.DoCDu ;G2 . G2C'2 ; Z2.6K ,critical ratio-

Cee5 y de$and (units) '6 'N 'K 'L 'F G2 G+C

.ro=a=i ity o4 de$and 7u$1.ro=1 2.+2 +.22 2.+6 2.F2 2.46 2.K6 2.46 2.62 2.+6 2.46 2.+2 2.+2 2 2 +.22

+LF

+F2

The optimal inventory level e%uals to 'K units. b. D2 ; 9ost.unit B 0\.unit;L6B '2 ; 66 M@ ,marginal lossDu ; Price.unit 8 9ost.unit ; +22 B K2 ; '2 M@ ,marginal profitP, 9-X ; Do.DoCDu ;66 . 66C'2 ; Z2.N6 ,critical ratio0o, the optimal inventory level e%uals to 'K units. Exa$p e -,: The J?9 9o. is planning to stoc" a new product. The 9o. Has developed the following information5 Jnnual usage ; 6G22 units 9ost of the product ; 'N6 M@.unit Ordering cost ; 66 M@.order 9arrying cost ; 4L7 .year of inventory value held. a <etermine the optimal number of units per order b. &ind the optimal number of orders.year c. &ind the annual total inventory cost #o ution: a. 12 ; W49?.)p ; W4X6G22X66.'N6X2.4L ; ZKN units.order b. 32 ; 9.12 ;6G22 . KN ; ZK+ orders.year c. De; W49?)p ; W4X6G22X66X'N6X2.4L ; KKF+.GN M@.year. Exa$p e --: Holding costs are '6 M@.unit.year. The ordering cost is +42 M@.order and sales are relatively constant at G22 month. a. (hat is the optimal order %uantityI b. (hat is the annual total inventory costI #o ution: a. 12 ; W49?.!; W4X,G22X+4-X+42.'6 ; +L+.G4 units.order b. De; W49?!; W4X,G22X+4-X+42X'6 ; N'GF.L2 M@.year

Exa$p e -2: +F2

+F+

J)im furniture company handles several lines of furniture, one of which is the popular :aybac" Model TT chair. The manager, Mr. &armerson, has decided to determine by use of the !OQ model the best %uantity to obtain in each order. Mr. &armerson has determined from past invoices that he has sold about 422 chair during each of the past five years at a fairly uniform rate and he expects to continue at that rate. He has estimated that preparation of an order and other variable costs associated with each order are about +2 M@, and it costs him about +.6 7 per month ,or +L7 per year- to hold items in stoc". His cost for the chair is LK M@. a. How many laybac" chairs should be ordered each timeI b. How many orders would there beI c. <etermine the approximate lenght of a supply order in daysI d. 9alculate the minimum total inventory cost e. 0how and verify that the annual holding cost is e%ual to the annual ordering cost ,due to rounding, show these costs are approximately e%ual#o ution: a. 12 ; W49?.)p ; W4X422X+2 .2.+LXLK ; +6.FL ;Z+N chairs.order b. 32 ; 9.12 ;422 .+N; +4.6 orders.year c. t2 ; 12.9 X 'N6 ; +N .422 X'N6 ; 4F.4 days d. De; W49?)p ; W4X422X+2X2.+LXLK ; 462.4L M@.year e. 32 X? ; +4.6 X +2 ; +46 M@ x.4X)p ; +6.FL.4 X 2.+LXLK ; +46.+ M@ Exa$p e -%: J. :eyla Tas has determined that the annual demand for TN screws is +22222 screws. :eyla, estimates that it costs +2 M@ every time when an order is placed. This cost includes wages, the cost of the forms used in placing the order and so on. &urthermore, she estimates that the cost of carrying are screw in inventory for a year is one8half of 2.2+ M@. Jssume that the demand is constant throughout the year. a. How many TN screws should :eyla order at a time to minimi)e total inventory costI b. How many orders per year would be placedI (hat would the annual ordering cost beI c. (hat would the average inventory beI (hat would the annual holding cost beI #o ution: +F+

+F4

a. !; 2.2+.4 ; 2.226 12 ; W49?.!; W4X+22222X+2 . 2.226 ; 42222 screws.order b. 32 ; 9.12 ; +22222.42222; 6 orders.year Total ordering cost ; 3X? ; 6X+2 ; 62 M@.year c. Jverage inventory ; x.4 ; 42222.4 ; +2222 units Total holding cost ; x.4X!; +2222 X 2.226 ; 62 M@.year ?. It ta"es approximately L wor"ing days for an order of TN screws to arrive once the order has been placed. The demand is fairly constant, and on the average the store sells 622 screws each day. (hat is the /OPI #o ution: /OP ; /o; use rate X lead time ; cXtlt ; 622 screws.day X L days ; G 222 screws. 9. The manager believes that :eyla places too many orders for screws .year. He believes that an order should be placed only twice.year. If :eyla follows her managerVs policy, how much more would this cost every year over the ordering policy that she developed, if only two orders were placed each year, what effect would this have on the /OPI #o ution: Twice a year ; De; 3? C 1.4X! ; 4X+2 C 62222.4X2.226 ; 42 C +46 ; +G6 6 times a year ; De; W49?! ; W4X+22222X+2X2.226 ; +22 M@ !xtra cost for manager*s offer ; G6 M@ 3o effect on /OP.

.ROALEM# +F4

+F'

+. The I)mir Petrol 9o. uses N22 %uarts of oil per month. The unit cost of a %uart of oil to the co. is 2.G2 M@ the cost of placing an order is +2 M@.9arrying charges are set at 447 of unit cost. &or all practical purposes demand is continuous and uniform. a- <etermine the optimum order si)e, ,!OQb- (hat is the total annual cost of optimum order policy, DeI c- If lead8time is one month, what is the re8order pt.I d- (hat is the annual cost of the total systemI ,This includes cost to meet demand4. J local maintenance firm uses 622 screwdrivers per month. The unit cost at a screwdriver is 2.62 M@. Ordering cost is L M@.order. :ead8time for processing an order is one month. The firm estimates that inventory holding charges a 2.42 M@ per +.22 M@ valuation per unit B year. &or purposes of maintaining an emergency stoc", management insists that the stoc" level never fall below 62 units. a- <etermine the economic order %uantity, ,!OQb- <etermine the optimum time between orders. c- (hat is the reorder pointI d- (hat is the total annual cost of this company*s systemI '. Product 1 is a standard item in J)im*s inventory. &inal assembly is performed on an assembly line, which is in operation every day. One of the components of product 1, component H<2L is produced in another department at the rate of +22 units per day. The assembly line uses H<2L at the rate of G2 per day. The firm operates 462 days each year. 0et up costs total 62 M@ and the average annual holding cost is 2.62 M@.unit8year. !ach component H<2L costs K M@ and re%uires a lead8time of K days. @sing this data, determine the following abcdThe optimal production lot si)e , O:0, The reorder point, 1ro The total annual cost of the optimal lot8si)e policy, De, (hat is the total annual costI ,"-

G. 0hoe Pla)a produces one style at shoe for which demand has averaged +622 units per month. !ach pair of these shoes that*s produced costs shoe pla)a 42 M@. Holding costs are set at N7 of cost per pair per year. !ach set up re%uires an outlay of G22mu. Jssuming no shortages are permitted, lead8time is two8months and #/eplacement8/uns$ is instantaneous, determine the following a- The optimum production lot8 si)e b- The total yearly cost to meet demand, c- The number of production runs per year, d- The time between orders, e- The reorder point.

+F'

+FG

+FG