CH 12

Inventory
Management
12
Copyright © 2017 Pearson Education, Inc. 12 - 1

Outline
► The Importance of Inventory
► Managing Inventory
► Inventory Models
► Inventory Models for Independent Demand
► Probabilistic Models and Safety Stock
► Single-Period Model
► Fixed-Period (P) Systems

Inventory Management
The objective of inventory

management is to strike a balance
between inventory investment and
customer service

Importance of Inventory
▶ One of the most expensive assets of
many companies representing as
much as 50% of total invested capital
▶ Less inventory lowers costs but
increases chances of running out
▶ More inventory raises costs but
always keeps customers happy

Functions of Inventory
1. To provide a selection of goods for
anticipated demand and to separate the
firm from fluctuations in demand
2. To decouple or separate various parts
of the production process
3. To take advantage of quantity discounts
4. To hedge against inflation

Types of Inventory
▶ Raw material
▶ Purchased but not processed
▶ Work-in-process (WIP)
▶ Undergone some change but not completed
▶ A function of cycle time for a product
▶ Maintenance/repair/operating (MRO)
▶ Necessary to keep machinery and processes
productive
▶ Finished goods
▶ Completed product awaiting shipment
The Material Flow Cycle
Cycle time
95% 5%
Input Wait for Wait to Move Wait in queue Setup Run Output
inspection be moved time for operator time time
Figure 12.1

Managing Inventory
1) How inventory items can be classified

(ABC analysis)
2) How accurate inventory records can
be maintained

ABC Analysis
▶ Divides inventory into three classes based
on annual dollar volume
▶ Class A - high annual dollar volume
▶ Class B - medium annual dollar volume
▶ Class C - low annual dollar volume
▶ Used to establish policies that focus on the
few critical parts and not the many trivial
ones

Percentage of annual dollar usage ABC Analysis
Figure 12.2
A Items
80 –
70 –
60 –
50 –
40 –
30 –
20 – B Items
10 – C Items
0 – | | | | | | | | | |
10 20 30 40 50 60 70 80 90 100
Percentage of inventory items

ABC Analysis
ABC Calculation
(1) (2) (3) (4) (5) (6) (7)
PERCENT
OF PERCENT
ITEM NUMBER ANNUAL ANNUAL OF ANNUAL
STOCK OF ITEMS VOLUME UNIT DOLLAR DOLLAR
NUMBER STOCKED (UNITS) x COST = VOLUME VOLUME CLASS
#10286 20% 1,000 $ 90.00 $ 90,000 38.8% A
72%
#11526 500 154.00 77,000 33.2% A
#12760 1,550 17.00 26,350 11.3% B
#10867 30% 350 42.86 15,001 6.4% 23% B
#10500 1,000 12.50 12,500 5.4% B
#12572 600 14.17 8,502 3.7% C
#14075 2,000 .60 1,200 .5% C
#01036 50% 100 8.50 850 .4% 5% C
#01307 1,200 .42 504 .2% C
#10572 250 .60 150 .1% C
8,550 $232,057 100.0%

ABC Analysis
▶ Other criteria than annual dollar volume may be used
▶ High shortage or holding cost
▶ Anticipated engineering changes
▶ Delivery problems
▶ Quality problems
▶ Policies employed may include
1. More emphasis on supplier development for A items
2. Tighter physical inventory control for A items
3. More care in forecasting A items

Problem 12.2
▶ Boreki Enterprises has the following 10 items in inventory.
Theodore Boreki asks you, a recent OM graduate, to divide
these items into ABC classifications
▶ a) Develop an ABC classification system for the 10 items.

▶ b) How can Boreki use this information?
▶ c) Boreki reviews the classification and then places item A2
into the A category. Why might he do so?

Problem 12.3
▶ Jean-Marie Bourjolly’s restaurant has the following inventory items
that it orders on a weekly basis:
▶ a) Which is the most expensive item, using annual dollar volume?

▶ b) Which are C items?
▶ c) What is the annual dollar volume for all 20 items?
Record Accuracy
► Accurate records are a critical ingredient in
production and inventory systems
► Periodic systems require regular checks of inventory
► Perpetual inventory tracks receipts and subtractions on
a continuing basis
► Incoming and outgoing record keeping must be
accurate
► Stockrooms should be secure
► Necessary to make precise decisions about
ordering, scheduling, and shipping

Cycle Counting
▶ Items are counted and records updated on a
periodic basis
▶ Often used with ABC analysis
▶ Has several advantages
1. Eliminates shutdowns and interruptions
2. Eliminates annual inventory adjustment
3. Trained personnel audit inventory accuracy
4. Allows causes of errors to be identified and corrected
5. Maintains accurate inventory records

Cycle Counting Example
5,000 items in inventory, 500 A items, 1,750 B items, 2,750 C
items
Policy is to count A items every month (20 working days), B items
every quarter (60 days), and C items every six months (120
days)
CYCLE
ITEM COUNTING NUMBER OF ITEMS
CLASS QUANTITY POLICY COUNTED PER DAY
A 500 Each month 500/20 = 25/day
B 1,750 Each quarter 1,750/60 = 29/day
C 2,750 Every 6 months 2,750/120 = 23/day

77/day

Problem 12.4
▶ Lindsay Electronics, a small manufacturer of electronic
research equipment, has approximately 7,000 items in
its inventory and has hired Joan Blasco-Paul to manage
its inventory. Joan has determined that 10% of the items
in inventory are A items, 35% are B items, and 55% are
C items. She would like to set up a system in which all A
items are counted monthly (every 20 working days), all B
items are counted quarterly (every 60 working days), and
all C items are counted semiannually (every 120 working
days). How many items need to be counted each day?

Control of Service Inventories
▶ Can be a critical component of profitability
▶ Losses may come from shrinkage or pilferage
▶ Applicable techniques include
1. Good personnel selection, training, and discipline
2. Tight control of incoming shipments
3. Effective control of all goods leaving facility

Inventory Models
▶ Independent demand - the demand for
item is independent of the demand for any
other item in inventory
▶ Dependent demand - the demand for
item is dependent upon the demand for
some other item in the inventory

Inventory Models
▶ Holding costs - the costs of holding or “carrying”

inventory over time
▶ Ordering cost - the costs of placing an order and
receiving goods
▶ Setup cost - cost to prepare a machine or process
for manufacturing an order
▶ May be highly correlated with setup time

Holding Costs
TABLE 12.1 Determining Inventory Holding Costs
COST (AND RANGE)
AS A PERCENT OF
CATEGORY INVENTORY VALUE
Housing costs (building rent or depreciation, 6% (3 -
operating costs, taxes, insurance) 10%)
Material handling costs (equipment lease or 3% (1 -
depreciation, power, operating cost) 3.5%)
Labor cost (receiving, warehousing, security) 3% (3 - 5%)
Investment costs (borrowing costs, taxes, and 11% (6 -
insurance on inventory) 24%)
Pilferage, space, and obsolescence (much 3% (2 - 5%)
higher in industries undergoing rapid change like
PCs and cell phones)
Overall carrying cost Holding costs vary considerably
26%depending on
the business, location, and interest rates.
Generally greater than 15%, some high tech and
Copyright © 2017 Pearson Education, Inc. fashion items have holding costs greater12 - than
22
Inventory Models for Independent
Demand
Need to determine when and

how much to order
1. Basic economic order quantity

(EOQ) model
2. Production order quantity model
3. Quantity discount model

Basic EOQ Model
Important assumptions
1. Demand is known, constant, and independent
2. Lead time is known and constant
3. Receipt of inventory is instantaneous and complete
4. Quantity discounts are not possible
5. Only variable costs are setup (or ordering) and holding
6. Stockouts can be completely avoided

Inventory Usage Over Time
Figure 12.3
Total order received

Average
Order Usage rate inventory
quantity = Q on hand
Inventory level
(maximum Q
inventory
level) 2
Minimum
inventory 0
Time

Minimizing Costs
Objective is to minimize total costs
Table 12.4(c)
Total cost of
holding and
setup (order)
Minimum
total cost
Annual cost
Holding cost
Setup (order) cost
Optimal order Order quantity

quantity (Q*)
Minimizing Costs
▶ By minimizing the sum of setup (or ordering) and

holding costs, total costs are minimized
▶ Optimal order size Q* will minimize total cost
▶ A reduction in either cost reduces the total cost
▶ Optimal order quantity occurs when holding cost
and setup cost are equal

D
Annual setup cost = S
Q
Minimizing Costs
Q = Number of pieces per order
Q* = Optimal number of pieces per order (EOQ)
D = Annual demand in units for the inventory item
S = Setup or ordering cost for each order
H = Holding or carrying cost per unit per year
Annual setup cost = (Number of orders placed per year)
x (Setup or order cost per order)
Annual demand Setup or order

=
Number of units in each order cost per order
æDö
= ç ÷S
èQ ø
Minimizing Costs D
Q
Q
Q = Number of pieces per order Annual holding cost =
2
H
Annual holding cost = (Average inventory level)
x (Holding cost per unit per year)
Order quantity
= (Holding cost per unit per year)
2
æQ ö
= ç ÷H
è2 ø
Minimizing Costs D
Q
Q
Q = Number of pieces per order Annual holding cost =
2
H
Optimal order quantity is found when annual setup

cost equals annual holding cost
æDö æQ ö Solving for Q* 2DS =Q2 H

ç ÷S = ç ÷H 2DS
èQ ø è2 ø Q2 =
H
2DS
Q* =
Copyright © 2017 Pearson Education, Inc.
H 12 - 30
An EOQ Example
Determine optimal number of needles to order
D = 1,000 units
S = $10 per order
H = $.50 per unit per year
*2DS
Q =
H
*2(1,000)(10)
Q = = 40,000 =200 units
0.50

An EOQ Example
Determine expected number of orders
D = 1,000 units Q* = 200 units
S = $10 per order
Expected Demand D
number of = N = = *
orders Order quantity Q
1,000
N= = 5 orders per year
200

An EOQ Example
Determine optimal time between orders
S = $10 per order N = 5 orders/year
Expected Number of working days per year

time between = T =
orders Expected number of orders
250
T= = 50 days between orders
5

An EOQ Example
Determine the total annual cost
S = $10 per order N = 5 orders/year
H = $.50 per unit per year T = 50 days
Total annual cost = Setup cost + Holding cost
D Q
TC = S+ H
Q 2
1,000 200
= ($10) + ($.50)
200 2
=(5)($10) + (100)($.50)
=$50 +$50 =$100
The EOQ Model
When including actual cost of material P
Total annual cost = Setup cost + Holding cost + Product cost
D Q
TC = S+ H + PD
Q 2

Robust Model
▶ The EOQ model is robust

▶ It works even if all parameters and
assumptions are not met
▶ The total cost curve is relatively flat in
the area of the EOQ

Only 2% less than
the total cost of $125
An EOQ Example when the order
quantity was 200
Determine optimal number of needles to order

D = 1,000 units1,500 units Q*1,000 = 200 units
S = $10 per order T = 50 days
H = $.50 per unit per year Q*1,500 = 244.9 units
N= 5 orders/year
Ordering old Q* Ordering new Q*
D Q
TC = S+ H
Q 2 1,500 244.9
= ($10) + ($.50)
1,500 200 244.9 2
= ($10) + ($.50)
200 2 =6.125($10) +122.45($.50)
=$75 +$50 =$125 =$61.25 +$61.22 =$122.47
Problem 12.9
▶ Henry Crouch’s law office has traditionally ordered
ink refills 60 units at a time. The firm estimates that
carrying cost is 40% of the $10 unit cost and that
annual demand is about 240 units per year. The
assumptions of the basic EOQ model are thought to
apply.
▶ a) For what value of ordering cost would its action
be optimal?
▶ b) If the true ordering cost turns out to be much
greater than your answer to (a), what is the impact
on the firm’s ordering policy?

Problem 12.14
▶ Thomas Kratzer is the purchasing manager for the
headquarters of a large insurance company chain with a
central inventory operation. Thomas’s fastest-moving
inventory item has a demand of 6,000 units per year. The
cost of each unit is $100, and the inventory carrying cost
is $10 per unit per year. The average ordering cost is $30
per order. It takes about 5 days for an order to arrive, and
the demand for 1 week is 120 units. (This is a corporate
operation, and there are 250 working days per year).

Problem 12.14 Conti.
▶ a) What is EOQ?
▶ b) What is the average inventory if the EOQ is used?
▶ c) What is the optimal number of orders per year?
▶ d) What is the optimal number of days in between any
two orders?
▶ e) What is the annual cost of ordering and holding
inventory?
▶ f) What is the total annual inventory cost, including the
cost of 6,000 units?

Problem 12.17
▶ M. Cotteleer Electronics supplies microcomputer circuitry to a
company that incorporates microprocessors into refrigerators and
other home appliances. One of the components has an annual
demand of 250 units, and this is constant through out the year.
Carrying cost is estimated to be $1 per unit per year, and the
ordering (setup) cost is $20 per order.
▶ a) To minimize cost, how many units should be ordered each time
an order is placed?
▶ b) How many orders per year are needed with the optimal policy?
▶ c) What is the average inventory if costs are minimized?
▶ d) Suppose that the ordering (setup) cost is not $20, and
Cotteleer has been ordering 150 units each time an order is
placed. For this order policy (of Q = 150) to be optimal, determine
what the ordering (setup) cost would have to be.

Reorder Points
▶ EOQ answers the “how much” question
▶ The reorder point (ROP) tells “when” to order
▶ Lead time (L) is the time between placing and
receiving an order
Demand Lead time for a new

ROP = per day order in days
ROP = d x L
d= D
Number of working days in a year

Reorder Point Curve
Figure 12.5
Q*
Stock is replenished as order arrives
Inventory level (units)
Slope = units/day = d
ROP
(units)
Time (days)
Lead time = L
Reorder Point Example
Demand = 8,000 iPhones per year
250 working day year
Lead time for orders is 3 working days, may take 4
D
d=
Number of working days in a year
= 8,000/250 = 32 units
ROP = d x L
= 32 units per day x 3 days = 96 units
= 32 units per day x 4 days = 128 units

Problem 12.13
▶ Annual demand for the notebook binders at
Duncan’s Stationery Shop is 10,000 units.
Dana Duncan operates her business 300 days
per year and finds that deliveries from her
supplier generally take 5 working days.
▶ a) Calculate the reorder point for the notebook

binders that she stocks
▶ b) Why is this number important to Duncan?

Production Order Quantity Model
1. Used when inventory builds up over a
period of time after an order is placed
2. Used when units are produced and
sold simultaneously Figure 12.6
Part of inventory cycle during which

Inventory level
production (and usage) is taking place

Demand part of cycle with no
production (only usage takes place)
Maximum
inventory
t Time
Q = Number of units per order p = Daily production rate
H = Holding cost per unit per year d = Daily demand/usage rate
t = Length of the production run in days
Annual inventory = (Average inventory level) x Holding cost

holding cost per unit per year
Annual inventory = (Maximum inventory level)/2

level
Maximum = Total produced during – Total used during

inventory level the production run the production run
= pt – dt

Maximum = Total produced during – Total used during

inventory level the production run the production run
= pt – dt
However, Q = total produced = pt ; thus t = Q/p
Maximum Q Q d
inventory level =p p –d p =Q 1–
p
Maximum inventory level Q d

Holding cost = (H) = 1– H
2 2 p

Setup cost = (D / Q)S

Holding cost = 21 HQéë1- d p ùû ( )
D
S = 21 HQé
ë1- d p ù
û ( )
Q
2DS
Q2 =
Hé
ë1-(d p ù
û )
2DS
Q*p =
Hé
ë1- d p
( ù
û )
Production Order Quantity Example
D = 1,000 units p = 8 units per day
S = $10 d = 4 units per day
H = $0.50 per unit per year
2DS
Q*p =
Hé
ë1- d p
( ù
û )
2(1,000)(10)
Q*p =
0.50é ù
ë1- (4 8)û
20,000
= = 80,000
0.50(1 2)
=282.8 hubcaps, or 283 hubcaps

Note:
D 1,000
d=4= =
Number of days the plant is in operation 250
When annual data are used the equation becomes:
2DS
Q*p =
æ Annual demand rate ö
H ç1- ÷
è Annual production rate ø

Problem 12.18
▶ Race One Motors is an Indonesian car manufacturer. At its
largest manufacturing facility, in Jakarta, the company
produces subcomponents at a rate of 300 per day, and it
uses these subcomponents at a rate of 12,500 per year (of
250 working days). Holding costs are $2 per item per year,
and ordering (set up) costs are $30 per order.
▶ a) What is the economic production quantity?

▶ b) How many production runs per year will be made?
▶ c) What will be the maximum inventory level?
▶ d) What is the annual cost of ordering and holding inventory?

Problem 12.20
▶ Arthur Meiners is the production manager of Wheel-Rite, a
small producer of metal parts. Wheel-Rite supplies Cal-Tex, a
larger assembly company, with 10,000 wheel bearings each
year. This order has been stable for some time. Setup cost for
Wheel-Rite is $40, and holding cost is $.60 per wheel bearing
per year. Wheel-Rite can produce 500 wheel bearings per
day. Cal-Tex is a just-in-time manufacturer and requires that
50 bearings be shipped to it each business day.
▶ a) What is the optimum production quantity?
▶ b) What is the maximum number of wheel bearings that will
be in inventory at Wheel-Rite?
▶ c) How many production runs of wheel bearings will Wheel-
Rite have in a year?
▶ d) What is the total setup and holding cost for Wheel-Rite?
Quantity Discount Models
▶ Reduced prices are often available when larger
quantities are purchased
▶ Trade-off is between reduced product cost and
increased holding cost
TABLE 12.2 A Quantity Discount Schedule
PRICE RANGE QUANTITY ORDERED PRICE PER UNIT P

Initial price 0 to 119 $ 100
Discount price 1 200 to 1,499 $ 98
Discount price 2 1,500 and over $ 96

Total annual cost = Setup cost + Holding cost + Product cost
D Q
TC = S+ IP + PD
Q 2
where Q = Quantity ordered P = Price per unit

D = Annual demand in units I = Holding cost per unit per year
S = Ordering or setup cost per order expressed as a percent of price P
2DS
Q* =
IP
Because unit price varies, holding cost is expressed

as a percent (I) of unit price (P)

Steps in analyzing a quantity discount
1. Starting with the lowest possible purchase
price, calculate Q* until the first feasible
EOQ is found. This is a possible best order
quantity, along with all price-break
quantities for all lower prices.
2. Calculate the total annual cost for each
possible order quantity determined in Step
1. Select the quantity that gives the lowest
total cost.
Figure 12.7
Initial
Price Discount Price 1 Discount Price 2
550,000 –
TC for No Discount
540,000 –
Annual Total Cost
TC for Discount 1
530,000 –
Not Feasible TC for Discount 2
520,053 –
517,155 –
Feasible
510,000 –
Not Feasible
Possible Order
500,000 – Quantities
120 1,500
Order Quantity
Quantity Discount Example
Calculate Q* for every discount *2DS
Q =
starting with the lowest price IP
2(5,200)($200)
Q$96* = = 278 drones/order
(.28)($96)
Infeasible – calculate Q*
for next-higher price
2(5,200)($200)
Q$98* = = 275 drones/order
(.28)($98)
Feasible

Quantity Discount Example
TABLE 12.3 Total Cost Computations for Chris Beehner Electronics
ANNUAL ANNUAL ANNUAL
ORDER UNIT ORDERING HOLDING PRODUCT TOTAL ANNUAL
QUANTITY PRICE COST COST COST COST
275 $98 $3,782 $3,773 $509,600 $517,155
1,500 $96 $693 $20,160 $499,200 $520,053
Choose the price and quantity that gives the

lowest total cost
Buy 275 drones at $98 per unit

Quantity Discount Variations
▶ All-units discount is the most popular form
▶ Incremental quantity discounts apply only to
those units purchased beyond the price
break quantity
▶ Fixed fees may encourage larger purchases
▶ Aggregation over items or time
▶ Truckload discounts, buy-one-get-one-free
offers, one-time-only sales

Problem 12.21
▶ Cesar Rego Computers, a Mississippi chain of computer
hardware and software retail outlets, supplies both
educational and commercial customers with memory and
storage devices. It currently faces the following ordering
decision relating to purchases of very high-density disks:
▶ D = 36,000 disks
▶ S = 25
▶ H = 0.45
▶ Purchase price = .85
▶ Discount price = 0.82
▶ Quantity needed to qualify for the discount = 6,000 disks
▶ Should
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Problem 12.22
▶ Bell Computers purchases integrated chips at $350 per chip.
The holding cost is $35 per unit per year, the ordering cost is
$120 per order, and sales are steady, at 400 per month. The
company’s supplier, Rich Blue Chip Manufacturing, Inc.,
decides to offer price concessions in order to attract larger
orders. The price structure is shown below.
▶ a) What is the optimal order quantity and the minimum annual cost
for Bell Computers to order, purchase, and hold these integrated
chips?
▶ b) Bell Computers wishes to use a 10% holding cost rather than
the fixed $35 holding cost in (a). What is the optimal order quantity,
and what
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Problem 12.26
▶ M. P. VanOyen Manufacturing has gone out on bid for a regulator
component. Expected demand is 700 units per month. The item
can be purchased from either Allen Manufacturing or Baker
Manufacturing. Their price lists are shown in the table. Ordering
cost is $50, and annual holding cost per unit is $5.
▶ a) What is the economic order quantity?

▶ b) Which supplier should be used? Why?
▶ c) What is the optimal order quantity and total annual cost of
ordering, purchasing, and holding the component?
Probabilistic Models and
Safety Stock
▶ Used when demand is not constant or certain
▶ Use safety stock to achieve a desired service
level and avoid stockouts
ROP = d x L + ss
Annual stockout costs = The sum of the units short

for each demand level x The probability of that
demand level x The stockout cost/unit
x The number of orders per year

Probabilistic Demand
Use prescribed service levels to set safety
stock when the cost of stockouts cannot be
determined
ROP = demand during lead time + ZsdLT
where Z = Number of standard deviations

sdLT = Standard deviation of demand
during lead time

Probabilistic Demand
Probability of Risk of a stockout

no stockout (5% of area of
95% of the time normal curve)
Mean ROP = ? kits Quantity

demand
350
Safety
stock
0 z
Number of
standard deviations
Probabilistic Example
m = Average demand = 350 kits
sdLT = Standard deviation of
demand during lead time = 10 kits
Stockout policy = 5% (service
level = 95%)
Using Appendix I, for an area under the curve of
95%, the Z = 1.645
In Excel, Z = Normsinv(S) = Normsinv(0.95) = 1.645
Safety stock = ZsdLT = 1.645(10) = 16.5 kits
Reorder point = Expected demand during lead time

+ Safety stock
= 350 kits + 16.5 kits of safety stock
= 366.5 or 367 kits
Problem 12.41
▶ Barbara Flynn is in charge of maintaining hospital
supplies at General Hospital. During the past year,
the mean lead time demand for bandage BX-5 was
60 (and was normally distributed). Furthermore, the
standard deviation for BX-5 was 7. Ms. Flynn would
like to maintain a 90% service level.
▶ a) What safety stock level do you recommend for

BX-5?
▶ b) What is the appropriate reorder point?

Problem 12.42
▶ Based on available information, lead time demand

for PC jump drives averages 50 units (normally
distributed), with a standard deviation of 5 drives.
Management wants a 97% service level.
▶ a) What value of Z should be applied?
▶ b) How many drives should be carried as safety
stock?
▶ c) What is the appropriate reorder point?

Single-Period Model
▶ Only one order is placed for a product
▶ Units have little or no value at the end of the
sales period
Cs = Cost of shortage = Sales price/unit – Cost/unit

Co = Cost of overage = Cost/unit – Salvage value
Cs
Service level =
Cs + Co

Single-Period Example
Average demand =  = 120 papers/day
Standard deviation =  = 15 papers
Cs = cost of shortage = $1.25 – $.70 = $.55
Co = cost of overage = $.70 – $.30 = $.40
Cs
Service level =
Cs + Co
.55 Service
= level
.55 + .40 57.9%
.55
= = .579  = 120
.95 Optimal stocking level

Single-Period Example
From Appendix I, for the area .579, Z  .20
The optimal stocking level
= 120 copies + (.20)()

= 120 + (.20)(15) = 120 + 3 = 123 papers
The stockout risk = 1 – Service level
= 1 – .579 = .422 = 42.2%

Problem 12.51
▶ Cynthia Knott’s oyster bar buys fresh Louisiana
oysters for $5 per pound and sells them for $9 per
pound. Any oysters not sold that day are sold to her
cousin, who has a nearby grocery store, for $2 per
pound. Cynthia believes that demand follows the
normal distribution, with a mean of 100 pounds and
a standard deviation of 15 pounds. How many
pounds should she order each day?

Problem 12.53
▶ University of Florida football programs are printed 1 week
prior to each home game. Attendance averages 90,000
screaming and loyal Gators fans, of whom two-thirds
usually buy the program, following a normal distribution,
for $4 each. Unsold programs are sent to a recycling
center that pays only 10 cents per program. The standard
deviation is 5,000 programs, and the cost to print each
program is $1.
▶ a) What is the cost of underestimating demand for each
program?
▶ b) What is the overage cost per program?
▶ c) How many programs should be ordered per game?
▶ d) What is the stockout risk for this order?
Fixed-Period (P) Systems
▶ Fixed-quantity models require
continuous monitoring using perpetual
inventory systems
▶ In fixed-period systems orders placed
at the end of a fixed period
▶ Periodic review, P system

▶ Inventory counted only at end of period
▶ Order brings inventory up to target level
▶ Only relevant costs are ordering and
holding
▶ Lead times are known and constant
▶ Items are independent of one another

Figure 12.9
Target quantity (T)
Q4
Q2
On-hand inventory
Q1 P
Q3
Time
Fixed-Period Systems
▶ Inventory is only counted at each review
period
▶ May be scheduled at convenient times
▶ Appropriate in routine situations
▶ May result in stockouts between periods
▶ May require increased safety stock

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Copyright:

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CH 12

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Inventory

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The objective of inventory

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1) How inventory items can be classified

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▶ a) Develop an ABC classification system for the 10 items.

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▶ a) Which is the most expensive item, using annual dollar volume?

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C 2,750 Every 6 months 2,750/120 = 23/day

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▶ Holding costs - the costs of holding or “carrying”

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Need to determine when and

1. Basic economic order quantity

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Total order received

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Setup (order) cost

Optimal order Order quantity

▶ By minimizing the sum of setup (or ordering) and

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Annual demand Setup or order

Optimal order quantity is found when annual setup

æDö æQ ö Solving for Q* 2DS =Q2 H

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Expected Number of working days per year

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Total annual cost = Setup cost + Holding cost

Total annual cost = Setup cost + Holding cost + Product cost

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▶ The EOQ model is robust

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Determine optimal number of needles to order

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Demand Lead time for a new

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▶ a) Calculate the reorder point for the notebook

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Part of inventory cycle during which