Discussion Questions

1. Describe four 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
3. What is the purpose of the ABC classification system ?
ABC classification system is used to establish policies that focus on the few critical parts
and not the many trivial ones
4. Identify and explain the types of costs that are involved in an inventory system .
Holding costs - the costs of holding or carrying inventory over time
Ordering costs - the costs of placing an order and receiving goods
Setup costs - cost to prepare a machine or process for manufacturing an order
-May be highly correlated with setup time
5. Explain the major assumption of the basis EOQ model .
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

7. Explain why it is not necessary to include product cost (price or price times
quantity) in the EOQ model , but the quantity discount model requires this information.

Price times quality is not variable in the EOQ model , but is in the discount model . When
quality discounts are variable ,the unit purchase price of the item depends on the order
quantity .
13. Describe the difference between a fixed quantity (Q) and a fixed-period (P)
inventory system .
In a fixed-quantity inventory system , when the quantity on hand reaches the reorder
point , an order is placed for the specified quantity . In a fixed-quantity inventory system , an
order is placed at the end of period . The quantity ordered is that needed to bring on-hand
inventory up to a specified level .
15. What is safety stock? What does safety stock provide safety against ?
Safety stock is inventory beyond average demand during lead time , held to control the
level of the shortages when demand and/or lead time are not constant ; inventory carried to
assure that the desired service level is reached .

PROBLEMS
12.1
Jean-Marie Bourjollys restaurant has the following inventory items that it
orders on a weekly basis :

INVENTORY ITEM
Ribeye Steak
Lobster tail
Pasta
Salt
Napkins
Tomato sauce
French Fries
Pepper
Garlic Powder
Trash can liners
Table cloths
Fish Fillets
Prime rib toast
Oil
Lettuce (case)
Chicken
Order pads
Eggs (case)
Bacon
Sugar

$VALUE/CASE
135
245
23
3
12
23
43
3
11
12
32
143
166
28
35
75
12
22
56
4

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

#ORDERED/WEEK
3
3
12
2
2
11
32
3
3
3
5
10
6
2
24
14
2
7
5
2

Exercise 12.1 Solution

Demand

Fish Fillets

143

10

1430

17.54

17.54

French Fries

43

32

1376

16.88

34.43

Chicken

75

14

1050

12.88

47.31

Prime rib toast

166

996

12.22

59.53

Lettuce (case)

35

24

840

10.31

69.83

Lobster tail

245

735

9.02

78.85

Ribeye Steak

135

405

4.97

83.82

Bacon

56

280

3.44

87.25

Pasta

23

12

276

3.39

90.64

Tomato sauce

23

11

253

3.1

93.74

Table cloths

32

160

1.96

95.71

Eggs (case)

22

154

1.89

97.6

Oil

28

56

.69

98.28

Trash can liners

12

36

.44

98.72

Garlic Powder

11

33

.4

99.13

Napkins

12

24

.29

99.42

Order pads

12

24

.29

99.72

Pepper

.11

99.83

Sugar

.1

99.93

Salt

.07

100

TOTAL

1083

Price Dollar Volume

Percent of $- Cumultv $-vol

Vol
%

Item name

8151

Fish Fillets
b) Which are C items?
Table cloths
Eggs (case)
Oil
Trash can liners
Garlic Powder
Napkins
Order pads
Pepper
Sugar
Salt
c) What is the annual dollar volume for all 20 items?
$ 8151

Category

12.2 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 items C are counted semiannually (every 120 working days) .
How many items need to be counted each day ?

ITEM
CLASS

PERCENT
OF ITEMS
(%)

QUANTITY

CYCLE
COUNTING
POLICY

10% 7000

700

Each Month (20

days)

NUMBER OF
ITEMS
COUNTED PER
DAY
700
=35/day
20

35% 7000

2450

Each Quarter (60

days)

2450
=41/day
60

55% 7000

3850

Each 6 months (120

days)

3850
=32/day
120

12.4 Boreki Enterprises has the following 10 items in inventory . Theodore Boreki asks
you , a recent OM graduate , to divide these items into ABC classifications.
ITEM
A2
B8
C7
D1
E9
F3
G2
H2
I5
J8

ANNUAL DEMAND
3000
4000
1500
6000
1000
500
300
600
1750
2500

COST/UNIT
50
12
45
10
20
500
1500
20
10
5

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

12.4 Solution
Demand

Price

Dollar Volume

Percent of $Vol

Cumultv $-vol
%

Category

G2

300

1500

450000

41.38

41.38

F3

500

500

250000

22.99

64.37

A2

3000

50

150000

13.79

78.16

C7

1500

45

67500

6.21

84.37

D1

6000

10

60000

5.52

89.89

B8

4000

12

48000

4.41

94.3

E9

1000

20

20000

1.84

96.14

I5

1750

10

17500

1.61

97.75

J8

2500

12500

1.15

98.9

H2

600

20

12000

1.1

100

Item name

TOTAL

21150

1087500

Created by POM-QM for Windows

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?
Because he want to classified the A2 is the high annual dollar volume item .

12.5 Williams Bevilles computer training school , in Richmond , stocks workbooks with
the following characterictics :
Demand D = 19500 units/year
Ordering cost S = $25/order
Holding cost H = $4/unit/year
12.5 Solution
Parameter

Value

Parameter

Value

19500

Optimal order quantity (Q*)

493.71

25

Maximum Inventory Level (Imax)

493.71

Holding cost(H)

Average inventory

246.86

Unit cost

Orders per period(year)

39.5

Annual Setup cost

987.42

Annual Holding cost

987.42

Unit costs (PD)

Total Cost

1974.84

Demand rate(D)
Setup/Ordering cost(S)

Created by POM-QM for Windows

a) Calculate the EOQ for the workbooks.
2 DS
Q=
H
Q=

2(19500)(25)
4
Q=493.71 units

b) What are the annual holding costs for the workbooks?

Annual holding cost = (Average inventory level) x (Holding cost per unit per year)
Q
H
2

493.71
($ 4 )
2

 $ 987.42

c) What are the annual ordering costs?

Annual setup cost = (Number of orders placed per year) x (Setup or order cost per order)
D
(S )
Q

19500
( $ 25 )
493.71

$ 987.42

12.23 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 costs is $50, and annual holding cost per unit is $5 .
ALLEN MFG
QUANTITY
1-499
500-999
1,000+

BAKER MFG
QUANTITY
1-399
400-799
800+

UNIT PRICE
$16.00
15.50
15.00

UNIT PRICE
$16.10
15.60
15.10

a) What is the economic order quantity ?

Economic Order Quantity is the order quantity that minimizes the total holding costs and
ordering costs .
12.23 Solution
Parameter

Value

Parameter

Value

700

Optimal order quantity (Q*)

118.32

50

Maximum Inventory Level (Imax)

118.32

Holding cost(H)

Average inventory

59.16

Unit cost

Orders per period(year)

5.92

Annual Setup cost

295.8

Annual Holding cost

295.8

Unit costs (PD)

Total Cost

591.61

Demand rate(D)
Setup/Ordering cost(S)

Created by POM-QM for Windows

b) Which supplier should be used ? Why ?
Allen Manufacturing because
c) What is the optimal order quantity and total annual cost of ordering , purchasing ,
and holding the component ?
Total Cost = Order Cost + Holding Cost + Purchase Cost
DS QH
+
+ PD
= Q
2

Quantity
410

Allen MFG
Total Cost
8400 410
+
+8400(16)
410
2

Quantity
410

= $ 136 449.36
500

1000

8400 50 0
+
+ 8400(15.5)
50 0
2
= $ 132 290
8400 100 0
+
+8400 (15)
100 0
2
= $ 128 290 (BEST)

Baker MFG
Total Cost
8400 410
+
+8400(50)
410
2
= $ 133 089.39

500

8400 50 0
+
+ 8400(1 5.5)
50 0
2
= $ 129 36.5

12.24 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 companys supplier , Rich Blue Chip Manufacturing , Inc ., decides to offer
price concessions in order to attract larger orders . The price structure is shown below .
Rich Blue Chips Price Structure
QUANTITY PURCHASED
1-99 UNITS
100-199 UNITS
200 OR MORE UNITS

PRICE / UNIT
$350
$325
$300

a) What is the optimal order quantity and the minimum annual cost for the Bell
Computers to order , purchased , and hold these integrated chips ?
D=400 , S=120 , P=350 , H=35 , P=35 , (35/20)120% = 29%
2 DS
Optimal order quantity = Q=
1P

9458

2(400)( 120)
(0.29)(35)

= 97 units
Total Cost = ( D/Q )(S) + (Q/2)(H) +PD
400
97
( 120 ) + ( 35 ) +(350)(400)
= 97
2
= 494.85 + 1697.50 + 140 000
= 142 192.35
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 is the optimal annual
cost ?
2 DS
2 DS
Optimal Order Quantity = Q =
=
1P
1P

12.32 Emarphy Appliance is a company that produces all kinds of major appliances . Bud
Banis , the president of Emarpy , is concerned about the production policy of the
companys best-selling refrigerator . The annual demand has been about 8000 units each
year , and this demand has been constant throughout the year . The production capacity is
200 units per day . Each time production starts, it costs the company $120 to move
materials into place , reset the assembley line , and clean the equipment . The holding cost
of a refrigerator is $50 per year . The current production plan calls for 400 refrigerators to
be produced in each production run . Assume there are 250 working days per year .
D= 8000 units per year
Production capacity = 200 units per day
Ordering cost / setup cost S= $ 120
Holding cost H= $ 50 per year
a) What is the daily demand of this product ?
Daily Demand , d =

8000 units
250 working days

= 32 units per day

b) If the company were to continue to produce 400 units each time production
starts , how many days would production continue ?
Q
400
P = 200 = 2 days
c) Under the current policy , how many production runs per year would be
required ?What would annual setup cost be?
Annual setup cost = (Number of orders placed per year) x (Setup or order cost per
order)

D
(S )
Q

8000
( 120 )
400

$ 240

d) If the current policy continues , how many refrigerators would be in inventory

when production stops ? What would the average inventory level be?
d
1
p )
Q
400(1

32
)
200

= 336
maximum 336
=
=168
Average inventory =
2
2
e) If the company produces 400 refrigerator at a time , what would the total annual
setup cost and holding cost be ?
168 (50 )+ 20 ( 120 )
$ 10 800

f) If Bud Banis wants to minimize the total annual inventory cost , how many
refrigerator should be produced in each production run ? How much would this
save the company in inventory costs compared to the current policy of producing
400 in each production run ?
2 DS
d
Q=
H (1 )
p

2(8000)(120)
32
50(1
)
200
= 213.81