Practice Problems

Inventory Control
Question 1: A supply chain consists of three stages, as shown in Figure 1. The first stage is Auto
Lights Ltd. (ALL) which manufactures headlights for automobiles. ALL has a warehouse for
finished goods attached to the factory. ALL has outsourced its shipping and logistics to another
company named Lights Delivery Ltd. (LDL). LDL has three warehouses dedicated to the
headlights. LDL ships headlights in batches from the factory warehouse to its own small regional
warehouses. LDL then ships headlights from its regional warehouses on a daily basis to
automobile plants.
Each of LDLs regional warehouses can hold a maximum of 1600 headlights. Because the
automobile plants demand for headlights is known well in advance and is stable, no safety stock
is maintained at any of the warehouses. Each regional warehouse ships 10,000 headlights per
month to the automobile plants. LDL has also determined that the economic order quantity
(EOQ) to ship headlights from ALL to its own regional warehouses is 1000 headlights. In other
words, each regional warehouse currently receives 10 shipments per month of 1000 headlights
per shipment from ALL. As a result, each truck carrying headlights from the factory warehouse to
a regional warehouse is 30% full. The cost of delivering an order from the factory warehouse to a
regional warehouse is the same for each of the regional warehouses. Also, the unit holding costs
are the same for each of the regional warehouses.

LDL is currently considering eliminating one or two regional warehouses. LDL has
divided the costs and benefits of eliminating warehouses into three categories:
1. Fewer regional warehouses will increase shipping costs from warehouses to geographically
dispersed automobile plants.
2. Selling warehouses will generate cash to invest elsewhere.
3. Consolidating inventories into fewer regional warehouses will change ordering costs and
inventory holding costs if order sizes are re-optimized.
The rest of this problem only focuses on resolving questions within category (3) above. For all
cases below assume that the shipment (from the factory warehouse) reaches the regional
warehouse when the on-hand inventory at the regional warehouse just falls to zero level.
(a) What is the average inventory in one of the regional warehouses?
(b) If LDL eliminates one warehouse, then the other two warehouses will each have to ship
15,000 headlights per month. LDL will continue ship in batches that minimize costs without
exceeding the capacity of the warehouses. What will be the new average inventory of each
regional warehouse?
(c) If LDL eliminates two warehouses, then the remaining warehouse will have to ship 30,000
headlights per month. LDL will continue to ship in batches that minimize costs without
exceeding the capacity of the warehouse. What will the new average inventory of the regional
warehouse be?
(d) Which will result in the lowest annual ordering and holding costs for LDL: three (regional)
warehouses, two warehouses, or one warehouse? Explain your answer.

Factory
warehouse

Regional
warehouse # 1

To
Automobile
Assembly
Plants

Headlight
Factory
Regional
warehouse # 2

ALL

Regional
warehouse # 3

LDL
Figure 1: Headlights Supply Chain Network

Question 2. A manufacturing company is procuring two different components, A and B, from

the same supplier. It is estimated that that the annual demand for A and B are 750 and 1225 units
respectively. The cost of ordering is Rs. 300 per order and the annual inventory carrying cost is
25%. The unit cost of A and B are Rs. 500 and Rs. 600 respectively.
The supplier and the company after suitable redesign were able to replace both components A and
B with a single substitute C (now requirements for either A or B will be met by component C).
However, the unit cost of this component is Rs. 750. Would you advise the company to go for the
substitute? Explain.
Question 3: A tire company carries a certain type of tire with the following characteristics.
Average annual sales = 500 tires
Ordering cost = $40/order
Carrying cost = 25% per year
Item cost = $40 per tire
Lead time = 4 days.
a) Calculate the EOQ.

b) For a Re-order Point policy (also called (Q,r) policy: see lecture notes slide Demand
Variability: Safety Stock) of inventory control, calculate the safety stock required for service
levels of 85, 90, 95, 97, and 99 percent. Assume standard deviation of demand per day is 10 units.
c) Construct a plot of inventory investment versus service level.
d) Based on (c) what service level would you establish on the basis of the graph in part (c).
Question 4: A regional warehouse purchases hand tools from various suppliers and then
distributes them on demand to retailers. The warehouse operates 5 days per week, 52 weeks per
year. Only when it is open can demand be experienced or orders received. The following data are
estimated for a certain type of hand drills:
Average daily demand = 100 drills
Standard deviation of daily demand = 30 drills
Lead time = 3 days
Holding cost = $9.30 per unit per year
Ordering cost = $35 per order
Cycle service level = 92%
The warehouse uses the (Q,r) inventory policy (see Question 3).
What should be the value of Q and r?
Question 5: A museum of natural history opened a gift shop two years ago. Managing
inventories has become a problem. Low inventory turnover is squeezing profit margins and
causing cash-flow problems. One of the top-selling items in the gift shop is a bird-feeder. Sales
are 18 units per week, and the supplier charges $60 per unit. The cost of placing an order with the
supplier is $45. Annual holding costs are 25% of a feeder's value, and the museum operates 52
weeks per year. Management chose a 390-unit lot size so that new orders could be placed less
frequently. What is the annual cost of the current policy of using a 390-unit lot size?
If the holding cost is mistakenly estimated as $30/unit/year and the lot size is changed to 53 units
then what is the percentage deviation of this lot size from the actual optimal lot size? What is the
deviation in cost?
Question 6: Matt Herron is the chief buyer at Investment Clothiers, a retail store known for
excellence in apparel. It is time to order merchandise for the Christmas season. During a recent
trip to Hong Kong, Matt spotted a particular mens overcoat that he expects will sell very well.
Based on past experience, Matt expects demand to range from 100 to 400 overcoats, with
probabilities that are as follows:
Estimate of seasons
demand
100
200
300
400

Probability

.10
.40
.40
.10

The total cost to Investment Clothiers would be $50 per overcoat, and the retail price is estimated at $90 per overcoat. Any overcoats left over after the Christmas season are expected to be
sold at $40 each.
(a) Suppose Matt buys 100 overcoats then what is his expected profit? Do the same for 200
overcoats, 400 overcoats.

(b) Determine how many overcoats Matt should buy if he wishes to maximise expected profits
over the coming Christmas season by using the newsboy model discussed in the class.
(c) The assumption of a discrete demand distribution is a bit artificial. Solve the problem using a
normal distribution for demand (with the same mean and standard deviation as the discrete
distribution of the original problem description). Does this change make much difference?
Question 7: Delt PC (DPC) sells computer equipment by mail and phone order in Germany. DPC
sells 1,200 computer screens a year. Ordering cost is 800 DM, and he estimates that his annual
inventory holding cost is 16 % per annum. The screens are purchased from the manufacturer at a
cost of 1,800 DM per screen. What is DPCs economic order quantity? What is DPCs ordering
and storage cost per screen? How long does a screen stay in inventory in DPCs store on
average? How do the above numbers change if DPC were to face a demand that is 4 times as
large as the one he contemplates currently?
Question 8: Video Rentals (VR) rents out VHS tapes by the night. When a movie
is released on video, they must decide how many tapes to keep for customers to rent.
While the run of the movie in the theatres is an indication of its popularity, there is still
considerable uncertainty about how many tapes will actually be rented.
A recent release is the movie Scream 3. VR has forecast that for the first week
the demand will be uniformly distributed, between 20 and 40 customers coming each
night to rent it. Each nightly rental brings in Rs 50 of revenues. However, VR must rent
these tapes from the distributor at Rs 15 per night.
a) How many tapes should VR keep on the shelves?
b) VR is apprehensive that in case they run out, customers will go to FoodWorld Video
Rental, where they are guaranteed availability. How will this change their decision? (Qualitative
answer)
Question 9: Foodworld bakes fresh bread every morning. Each loaf is sold for Rs 20. If a loaf is
not sold on the first day, it is put on sale as "Day-Olds" for Rs 7.50. It costs Rs 12.50 to bake a
loaf of bread. Meanwhile, demand depends on the day of the week. They are all uniformly
distributed. The following table shows the demand on days of the week:
Day of the week

Demand

Weekday
Saturday
Sunday

100-200
300-325
200-250

a) How many loaves should they bake every morning?

b) How will your decision change if a large number of these customers will buy the day-olds?
(Qualitative answer)
Question 10: In a periodic review system, the leadtime for gadgets is 2 weeks and the review
period is 1 week. Demand during the protection interval is 218 units, with a standard deviation of
40 units. What is the cycle service level if the target inventory level is set at 300 units?