INVENTORY MANAGEMENT - Numerical Examples Problem 1 A plant makes monthly shipments of electric drills to a wholesaler in average lot sizes

of 280 units. The wholesalers average demand is 70 units per week and the lead time from the plant is three weeks. The wholesaler must pay for the inventory from the moment plant makes a shipment. If the wholesaler is willing to increase its purchase quantity to 350 units the plant will guarantee a lead time of two weeks. What is the effect on cycle and pipeline inventories? Present situation when the wholesaler orders in lot sizes of 280 units. Cycle inventory = Q/2 = 280/2 = 140 units. Pipeline inventory = Average demand X Lead time = 70 X 3 = 210 units When the average lot size increases to 350 units, Cycle inventory = 350/2 = 175 units Pipeline inventory = 70 X 2 = 140 units Effect: Cycle inventory increases from 140 to 175 units; that is by 35 units or 25 % Pipeline inventory reduces from 210 units to 140 units; that is by 70 units or 33% The lead time reduces from three weeks to two weeks. This is advantage to wholesaler because of commitment for payment only for two weeks in advance rather than three weeks. Problem 2 Sharp Needles Co. markets special hypodermic needles to hospitals and is interested in reducing their inventory. The annual demand is 1000 units, the setup cost or ordering cost is Rs.10 per order and the cost of holding is Rs.0.50 per unit per year. Each hypodermic needle costs Rs.10. Calculate (1) Economic Order Quantity, (2) Number of orders, (3) Expected time between orders, (4) Total cost of inventory and (5) Total annual cost. Assume 250 working days per year. Economic Order Quantity, Number of orders (N), and Expected time between orders (T) are calculated as follows:

EOQ =

2DS 2 (1000) (10) = = 200 Units H 0.50 Annual Demand 1000 N= = =5 EOQ 200
Number of working days per year 250 = = 50days Number of orders per year 5

T=

Total cost of inventory (TCI) is the sum of annual ordering cost and holding cost and is calculated as follows:

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D EOQ X S+ XH EOQ 2 1000 200 TCI = X 10 + X 0.50 = Rs.100 200 2 TCI = Total annual cost (TAC) is the sum of the Total inventory cost and the total annual material cost. Therefore, TAC = TCI + Annual Demand X Unit cost Hence, TAC = Rs.100 + 1000 X Rs.10 = Rs.10100. Problem 3 Consider problem 1. If the demand increases to1500 units, and the same order quantity is used, what is the total cost of inventory? Determine the total costs if new order quantity is used? Compare the two cases and comment. First we calculate the new economic order quantity considering the increased demand. New EOQ = 2DS 2 (1500) (10) = = 244.9 or 245Units H 0.50

Total inventory cost with increased demand and old order quantity is as follows: D EOQ TCI = X S+ XH EOQ 2 1500 200 TCI = X 10 + X 0.50 = Rs.125 200 2 Total inventory cost with increased demand and new economic order quantity is as follows: D EOQ TCI = X S+ XH EOQ 2 1500 245 TCI = X 10 + X 0.50 = Rs.122.47 245 2 Comments: Comparing the two TCIs, we observe that the TCI with old EOQ when the demand is 1500 units, increases by (Rs.125 Rs.122.47) Rs. 2.53 or (2.53/122.47 X100) 2.06%. This means even when the demand went up by 50%, TCI with old EOQ resulted in slight increase only. -----------------------------------------------------------------------------------------------------------Problem 4 A distributor operates a 250-day working year and the annual demand is 8000 units. The average time to receive an order is 3 working days. Calculate the reorder point.

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Annual demand 8000 = = 32 Units Number of working days in a year 250 Therefore, Reorder point, ROP = Average lead time in days X Daily demand ROP = 3 X 32 = 96 Units. Thus, when inventory drops to 96 units , an order should be placed. -----------------------------------------------------------------------------------------------------------Problem 5 Using the following data, find the EOQ, Reorder point, and Total annual cost: Annual demand, D = 1000 units Ordering cost, S = Rs.5.00 per order Holding cost, H = Rs.1.25 per unit per year. Lead time, L = 5 days Cost per unit, P = Rs. 12.50 Daily demand = Economic Order Quantity (EOQ) is given by, EOQ = 2O D H = 2 (5) (1000) = 89.4 Units 1.25

Therefore EOQ = 90 Units Reorder point = Daily usage X Lead time Reorder point = (1000/365) X 5 = 13.7 Units. 14 Units This means, when the inventory drops to 14 units, an order for 90 units is to be placed. Total annual cost (TAC) is the sum of the Total inventory cost and the total annual material cost. Therefore, TAC = TCI + Annual Demand X Unit cost D EOQ TAC = X S+ X H +DX P EOQ 2

1000 90 X 5+ X 1.25 + 1000 X 12.50 = Rs.12612 90 2 Problem 6 A manufacturer gets an order to supply 24000 units over a period of one year. The set up cost is Rs.200 per run and the inventory carrying cost is 12% of the unit cost. Each unit costs Rs.5. Determine the (a) Economic lot size, (b) number of production runs, and (c) duration of each run if the plant capacity is 2000 units per month. Economic lot size (ELS) is given by: TAC =
ELS = 2O D 2 X 200 X 24000 = = 4000Units iP 0.12 X 5 24000 =6 4000

Number of production runs = Annual demand / ELS = = Duration of each run = ELS / Production rate =

4000 = 2 months 2000

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Problem 7 Hayes electronics sells a particular brand of microcomputer. It costs the firm $450 each time it places an order with the manufacturer. The cost of carrying inventory for one microcomputer is $170 per year. The estimated annual demand is 1200 units. The store is open every day of the year except Christmas Day. Determine the following: (a) Optimal order quantity per order (b) Minimum total annual inventory costs, (c) The number of orders per year, and (d) The time between orders (in working days) Problem 8 Nathan manufacturing Company makes and sells specialty hub caps for the retail automobile market. The annual demand is 1000 units with an average daily demand of 4 units. The company produces 8 units per day. Set up costs are Rs.10 and holding cost is Rs. 0.50 per unit per year. The plant operates 250 days a year. Determine the optimal quantity per order. The optimal order quantity is given by:

Q* = p

2DS 2 (1000) (10) = =282.8 ; 283 Hubcaps d 4 0.50 1 H 1 8 p

Problem 9 A manufacturer of electrical products is required to purchase 2400 stampings per year. These stampings are subject to quantity discount of Rs.0.75 from the quoted price of Rs.10, if the purchased quantity is 3000 units or more at any time. The ordering cost is Rs.100 and inventory carrying cost is 24% per year. Find the optimum ordering quantity, number of orders to be placed per year, and order interval when the working days in a year are 300. EOQ without considering the price discount:

EOQ =

2O D 2 X 100 X 2400 = = 447.213 Units or 447 Units iP 0.24 X 10

Total annual cost (TAC) is the sum of the Total inventory cost and the total annual material cost. Therefore, TAC = TCI + Annual Demand X Unit cost

D EOQ X S+ X H +DX P EOQ 2 2400 447 TAC = X 100 + X 0.24 X 10 + 2400 X 10 = Rs.25073.3 447 2 TAC =
If the order quantity is 3000 units, then the total annual cost is given by,

TAC =

2400 3000 X 100 + X 0.24 X 9.25+ 2400 X 9.25= Rs .25610 3000 2

We observe that TAC (with order quantity = 447 Units) is less than TAC (with order quantity = 3000 units). Therefore the order quantity should be 447 units only and discount should not be availed.

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Problem 10 A toy car distributor offers quantity discounts as follows: For order quantity 0 to 999 toy cars, unit cost is $5.00 For order quantity 1000 to 1999 toy cars, unit cost is $4.80 For order quantity 2000 or more, unit cost is $4.75 Ordering cost is $49.00 per order, annual demand is 5000 toy cars, and inventory carrying charge is 20% of the unit cost. Determine the optimal ordering quantity. The first step is to compute EOQ for every unit price.

EOQ, Q1 =
EOQ, Q 2 =

2O D 2 X 5000 X 49 = = 700 Units iP 0.2 X 5

2O D 2 X 5000 X 49 = = 714 Units iP 0.2 X 4.80

EOQ, Q3 =

2O D 2 X 5000 X 49 = = 718Units iP 0.2 X 4.75

EOQ, Q1 is within the range and hence can be retained as 700. But to avail discount, both Q2 and Q3 need to be adjusted upward as follows: Q2 = 1000, and Q3 = 2000. As the next step, the total annual cost is calculated using the values of Q as follows: Order Unit quantity price,$ 700 1000 2000 $5.00 $4.80 $4.75 Annual material cost,$ 25000 24000 23750 Annual ordering cost. $ 350 245 122.50 Annual holding cost, $ 350 480 950 Total Annual Cost, $ 25700 24725 24822.50

From the Table it is observed that the total annual cost is minimum for an order quantity of 1000 units. Therefore the optimal ordering quantity is 1000 units. Probabilistic Models and Safety Stock The service level is the complement of the probability of a stockout. For example, if the probability of a stockout is 0.05, then the service level is 0.95. Uncertail demand raises the possibility of stockout. One method of reducing stockouts is to hold extra units in inventory and such stock is called safety stock or buffer stock. Considering safety stock reorder point becomes, ROP = Average daily demand X Lead time in working days + Safety stock ROP = d X L + SS Annual stockout cost = The sum of the units short X The probability X The stockout per unit X The number of orders per year

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Problem 11 An optical company uses a reorder point of 50 units. Its carrying cost is $5 per unit per year and the stockout cost (or lost sale) is $40 per unit. The number of orders per year is six. The demand during the reorder period has the following probability distribution: Number of units Probability 30 0.2 40 0.2 50 0.3 60 0.2 70 0.1 Determine the safety stock to be maintained. Safety Additional Stockout cost, $ Total stock holding cost,$ cost, $ 0 0 [(10) (0.2) + (20) (0.1)]($40)(6) = 960 960 10 (10) (5) = 50 [(10) (0.1)]($40)(6) = 240 290 20 (20) (5) = 100 0 100 The total cost is a minimum for a safety stock of 20 units. Therefore the reorder point is 50 + 20 = 70 units. Problem 12 A hospital keeps an emergency kit that has a normally distributed demand during the reorder period. The mean demand during the reorder period is 350 kits and the standard deviation is 10 kits. The hospital administration has decided to follow a policy that results in stockouts only 5% of the time. Determine the safety stock to be used. What reorder point should be used? Safety stock = x x Because, Z = , Safety stock = Z Therefore Safety stock = 1.65 X 10 = 16.5 kits. Reorder point is 350 + 16.5 = 366.5 or 367 kits

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