CHAPTER 8

INVENTORY MODELS
TRUE/FALSE QUESTIONS
1.
Inclusion of quantity discounts may influence both the order
quantity and the reorder point. (False, medium)
2.
In the continuous review system, order quantity tends to be
fixed, and order time is variable. This is reversed in a periodic
review system. (True, medium)
3.
In the planned shortage model, you cannot recommend a maximum
inventory position of zero. (False, medium)
4.
Excess inventory should be avoided if at all possible, since it
must be either sold at a discount, sold for salvage, or dumped.
(False, easy)
5.
Insufficient inventory should be avoided if at all possible
since it can result in lost business. (False, easy)
6.
An inventory policy has two components:
the reorder point. (True, easy)

the order quantity and

7.
Holding costs and procurement/manufacturing costs are both
functions of the unit cost of the item. (True, easy)
8.
The economic order quantity model assumes the item has little
or no shrinkage. (True, easy)
9.
The inventory holding cost is proportional to the order
quantity, but the annual ordering cost is inversely proportional to
the order quantity. Annual procurement costs do not depend on the
order quantity. (True, medium)
10.
Quantity discounts reduce the unit price. Inventory costs are
always reduced by opting for a quantity discount. (False, easy)
MULTIPLE CHOICE QUESTIONS
2.
The strongest factor influencing the choice of inventory model
is the:
a.
b.
c.
d.

pattern of demand.
value of the inventoried item.
presence or absence of quantity discounts.
presence or absence of safety stocks.

(a, medium)
3.

"Shrinkage" of inventory includes:

a.
b.
c.

reduced unit value.

theft.
obsolescence.

d.

misplacement.

(b, medium)
4.
for:

In the ABC classification system, "C" items typically account

a.
b.
c.
d.

roughly half the annual production value.

around half the number of inventory SKU's.
approximately one-third of annual inventory usage.
the smallest share of the total inventory.

(b, medium)
5.
In the economic order quantity (EOQ) model, if the holding cost
and the ordering cost both double, the value of Q* will:
a.
b.
c.
d.

decrease by 50%.
remain unchanged.
double.
quadruple.

(b, medium)
7.
In the basic economic order quantity (EOQ) model, at Q* the
estimated total annual holding cost:
a.
b.
c.
d.

is less than the estimated total annual ordering cost.

equals the estimated total annual ordering cost.
is greater then the estimated total annual ordering
cost.
bears no necessary relationship to estimated total
annual ordering cost.

(b, difficult)
8.
In the basic economic order quantity (EOQ) model, if monthly
demand is a constant 430 units, the order quantity is 144 (12 dozen),
and the firm operates during fifty five-day weeks a year, the cycle
time will be approximately:
a.
b.
c.
d.

7 working days.
7 calendar days.
84 working days.
cannot be determined with the data provided.

(a, difficult)
9.
For the production lot size model to be appropriate, the
relationship between D, annual demand, and P, maximum annual
production rate, must be:
a.
b.
c.
d.

D > P.
D = P.
D < P.
no necessary relationship exists.

(c, easy)
11.

In the production lot size model:

a.
b.
c.
d.

the maximum inventory position, M, equals Q*.

additions to, and withdrawals from, inventory occur at
equal rates.
at Q*, annual production setup costs equal annual
holding costs.
at Q*, annual production setup costs exceed annual
holding costs.

(c, medium)
12.
In the planned shortage model, a zero value for R, the reorder
point, means:
a.
b.
c.
d.

reorder only when a customer appears.

instantaneous inventory replenishment.
reorder when the back-order position is zero.
reorder in a quantity equal to the back-order position.

(c, medium)
FORMULATION/SOLUTION/ANALYSIS QUESTIONS
2.
Garner is your sole supplier of gremmels, a key component in
the Farfel unit your company produces and sells. Formerly, you
ordered from Garner 800 units monthly, to meet an annual need
(demand) for 9600 units. Purchase cost was $3.00 per unit. Now,
however, Garner is offering discounts of 7% on orders of 1500 or
more, and 15% on orders of 3000 units or more. Orders are placed and
filled at a cost of $32 per order. Inventory holding cost is
estimated at 20% of purchase cost, per item, per year. Under the new
discount plan, what is your best strategy?
(At $3.00, Q* = 1,011.
Q* = 1,098.

At 7% discount, Q* = 1,049.

At 15% discount,

TC(1,000) = 9600(3)
+ (1000/2)(.60) + (9600/1000)(32) = $29,407.
TC(1500) = 9600(2.79) + (1500/2)(.558) + (9600/1500)(32) = $27,407.
TC(3000) = 9600(2.55) + (3000/2)(.51) + (9600/3000)(32) = $25,347.
Thus, now purchase 3000 per order, 3.2 times per year.)

(medium)

3.
The annual demand for inventory item 67J is 6000 SKU's. Order
lead time is 6 workdays, and the firm's "year" is 300 days (6
workdays weekly, times 50 weeks). Empirical analysis indicates that
the daily standard deviation of SKU demand is 4 units. If the firm
desires only a 5% chance of a stockout, during any inventory cycle:
A. What is the corresponding safety stock level?
( (z)() = (1.645)(9.798) = 16.118. Round up to 17.
Note: daily s.d. = 4;
daily variance = 16;

lead time variance = (6)(16) = 96;

lead time s.d. = 9.798.)
B. What is the corresponding reorder point, R?
(R = mean + (z)() = L x D + 16.118
= 6(6000/300) + 16.118 = 136.118, call it 137.)
C. Suppose Q* = 400. Now if the firm is willing to be out of stock of
67J, an average of no more than two inventory cycles per year, what
should be the safety stock level?
(6000/400 = 15 cycles per year. 2/15 = 0.1333, and corresponding
z = 1.111.
(z)() = 1.111(9.798) = 10.89, or 11 SKUs.) (difficult)