Answer:

Introduction
According to Armstrong and Hilton (2011) companies should adopt the maintenance of economic
order quantity so that the companies can manage the inventory and maximize the profit through
continuous review of the system. The report deals with the ascertainment of the economic order
quantity of Weather Teddy which is a new range of product introduced by the Specialty Inc.

Normal probability distribution of the sales forecast

The Normal distribution curve
Carlberg (2011) commented that normal distribution curve which is also known as the bell curve
refers to the shape created when a line is plotted using the data points for an item that meets the
criteria of normal distribution. The centre of the curve is the highest point containing the greatest
value. The centre point is referred as the mean of the curve. The bell curve decreases on the
either side of the centre thereby outlining the standard deviations of the curve. The standard
deviation determines the height and the width of the bell.

Calculation of the mean and standard deviation

Mean = 20000 (Expected demand)
So P (10k < X < 30k) = 0.95
By symmetry
P (20k< X < 30k) = 0.475
P (0< Z < 10k/σ ) = 0.475
From normal tables, Z value corresponding to this 0.475 is 1.96
So 10000/σ = 1.96
Or, 1.96 = 10000/σ
Or, Standard deviation is 10000/1.96
= 5102. 04 or approximated to 5102
In the above calculation it can be said that 95% of the normal distribution falls between 10000
and 30000 hence 47.5% falls between 20000 and 30000. From the normal distribution table the
value of 47.5% can be determined as 1.96 (Standard deviation). Hence the required standard
deviation is around 5102. The mean for the purpose of calculation is assumed to be the 20000
units which is the expected demand for the company’s sell.

Normal distribution curve

Computation of probability of stock out for order quantities
Stock out may be defined as the situation where the current market demand cannot be fulfilled by
the company from the current inventory (Diday, 2013). The issue of stock out is a grave issue for
the consumers. Since the stock out will hamper the demand of the customers. A stock out is when
virtual inventory has been depleted and is no longer available from either the supplier or the
retailer. The majority of the cases of stock out are seen in cases of retail companies. In the case
of Specialty Inc the management depending upon the various suggested quantities tried to
calculate the stock out probabilities for each quantity. The variation in the order quantities shows
that being a retail company Specialty Inc has formulated the various ranges of order quantity so
that the stock out risks can be managed.
The profitability of stock out with an order of K units is P(X > K)
P (X > K) = P (Z > (K – 20000) / 5102
Here Z is the standard normal
The order quantities suggested by the management of Specialty Inc are namely 15000, 18000,
24000 and 28,000

Order ( K) (K – 20000) / 5102 P ( X > K)

15000 -0.98001 0.83

18000 -0.392 0.65

24000 0.784006 0.21

28000 1.568012 0.05

Computation of projected profits
The projected profits are calculated based on the three different scenarios adopted by the
management of the company (Sprinthall, 2012). The management of the company adopted the
worst case scenario, the most likely scenario and the best scenario and with the help of the
ordering quantities calculated the profit that the company will experience in each case. In the
calculation of the same the company took into account two types of profit rates firstly the initial
profit rate of $ 8 and secondly the surplus profit rate of $11 for the excess of the ordering quantity
(Härdle and Simar, 2012).

Projected profits for order quantity of 15000

The initially cost price is $ 16 and the initial selling price is $ 24 and after holiday the company will
sell the surplus at $ 5 selling price.
Profit initially = (24-16)
=$8
Profit later = (16- 5)
= $ 11

Most likely case

Worst case scenario Best case scenario
scenario
(10000) (30000)
(20000)

(8*10000) - (11*5000)
(8 * 15000) = 120000 (8 * 15000) = 120000
= 25000

Projected profits for order quantity of 18000

The initially cost price is $ 16 and the initial selling price is $ 24 and after holiday the company will
sell the surplus at $ 5 selling price.
Profit initially = (24-16)
=$8
Profit later = (16- 5)
= $ 11

Most likely case

Worst case scenario Best case scenario
scenario
(10000) (30000)
(20000)
 (8*10000) - (11*8000)
(8 * 18000) = 144000 (8 * 18000) = 144000
= -8000

Projected profits for order quantity of 24000

The initially cost price is $ 16 and the initial selling price is $ 24 and after holiday the company will
sell the surplus at $ 5 selling price.
Profit initially = (24-16)
=$8
Profit later = (16- 5)
= $ 11

Most likely case

Worst case scenario Best case scenario
scenario
(10000) (30000)
(20000)

(8 * 20000) – ( 11 *
(8*10000) - (11*14000)
4000) (8 * 24000) = 192000
= -74000
= 116000

Projected profits for order quantity of 28000

The initially cost price is $ 16 and the initial selling price is $ 24 and after holiday the company will
sell the surplus at $ 5 selling price.
Profit initially = (24-16)
=$8
Profit later = (16- 5)
= $ 11

Most likely case

Worst case scenario Best case scenario
scenario
(10000) (30000)
(20000)

(8 * 20000) – ( 11 *
(8*10000) - (11*18000) (8 * 28000)
8000)
= -118000 = 224000
= 72000

Computation of ordering quantities

As per the management the ordering quantity which will meet 70% demand and has a probability
of 30% stock out can be found as follows:
P(X < K) = 0.70
P (Z < (K – 20000) / 5102) = 0.70
Or, (K – 20000) / 5102 = 0.5244 (As per the corresponding value of Z in normal distribution table)
K = (20000 + 5102) * 0.5244
= 20000+2675
= 22675 (Economic order quantity)
Objected profit under three diverse sales scenario

Best case
Worst case scenario Most likely case scenario
scenario
(10000) (20000)
(30000)

(8*10000) - (11*12675) (8 * 20000) – ( 11 * 2675) (8 * 22675)

= -59425 = 130575 = 181400
Recommendation
The order quantity that the company should maintain should range between 20000 and 25000.
The management had determined that with a order quantity of around 22675 the profitability of
the company increases to 70% and the probability of stock out reduces to 30%. Moreover the
most likely scenario considered by the company management is 20000. Hence keeping the order
quantity between the range of 20000 and 25000 will neither put the company at risk of stock out
nor keep excess amount of stock for the company. Moreover the company will also be able to
maintain a steady amount of profit in this range of stock. The probability of stock out for the
company under the option of most likely range of ordering quantity is also low that is .21 or
21%.Weather Teddy is a new addition to the existing product line of the toy company. Although
the product is designed in an innovative manner in order to cater to the needs of the children in
an informative as well as innovative manner. However since the product is a toy hence it is not
possible to measure the demand graph of the product and it is not possible to judge the amount
of ordering quantity in order to balance the situations of stock out. If the company adopts the best
possible scenario and orders products ranging between 26000 and 30000 then if the product flops
in the market then the company may get stuck with the high levels of inventory in the warehouse
along with high levels of cost of production and inability to recover the variable costs. In that
situation the company would have to sell the goods at reduced prices. Hence it is advisable to
maintain a lower level of ordering quantity initially and after judging the demand level the company
can effectively increase the amount of ordering quantity.