MM6041 - Supply Chain Design (1-2020)

Name: Ni Cening Devantari

NIM: 29119098
Inventory Management and Risk Pooling Assignment

1. Joe Henry’s machine shop uses 2500 brackets during the course of a year. These brackets
are purchased from a supplier 90 Miles away. The following information is known about
the brackets:
Annual Demand (D) 2500
Holding cost per bracket per year (h) $1.5
Order cost per order (K) $18.75
Lead Time 2 days
Working days per year 250 days

What would be the EOQ?

Economic order quantity (EOQ) is the ideal order quantity a company should purchase to
minimize inventory (Investopedia, 2020). The calculation is shown below:

2𝐾𝐷 2(18.75)(2500)
𝐸𝑂𝑄 = 𝑄 ∗ = √ =√ = 𝟐𝟓𝟎 𝒖𝒏𝒊𝒕
ℎ 1.5

Given the EOQ, what would be the average inventory? What would be the annual
inventory holding cost?
Average inventory is a calculation that estimates the value or number of a particular good or
set of goods during two or more specified time periods (Investopedia, 2019). The calculation
is shown below:
𝑄 250
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 = = = 𝟏𝟐𝟓 𝒖𝒏𝒊𝒕
2 2
While for the annual inventory holding cost is:
ℎ𝑄 ($1.5)(250)
𝐴𝑛𝑛𝑢𝑎𝑙 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 ℎ𝑜𝑙𝑑𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 = = = $𝟏𝟖𝟕. 𝟓
2 2
Given the EOQ, how many orders would be made each year? What would be the annual
order cost?
𝐷 2500
𝐻𝑜𝑤 𝑚𝑎𝑛𝑦 𝑜𝑟𝑑𝑒𝑟𝑠 𝑒𝑎𝑐ℎ 𝑦𝑒𝑎𝑟 = = = 𝟏𝟎 𝒕𝒊𝒎𝒆𝒔
𝑄 250
𝐴𝑛𝑛𝑢𝑎𝑙 𝑜𝑟𝑑𝑒𝑟 𝑐𝑜𝑠𝑡 = (𝑇𝑜𝑡𝑎𝑙 𝑜𝑟𝑑𝑒𝑟𝑠 𝑖𝑛 𝑦𝑒𝑎𝑟)(𝐾) = $𝟏𝟖𝟕. 𝟓
Given the EOQ, what is the total annual cost of managing the inventory?
𝑇𝑜𝑡𝑎𝑙 𝑎𝑛𝑛𝑢𝑎𝑙 𝑐𝑜𝑠𝑡 𝑜𝑓 𝑚𝑎𝑛𝑎𝑔𝑖𝑛𝑔 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦
= 𝐴𝑛𝑛𝑢𝑎𝑙 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 ℎ𝑜𝑙𝑑𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 + 𝐴𝑛𝑛𝑢𝑎𝑙 𝑜𝑟𝑑𝑒𝑟 𝑐𝑜𝑠𝑡
= $𝟏𝟖𝟕. 𝟓 + $𝟏𝟖𝟕. 𝟓 = $𝟑𝟕𝟓
 MM6041 - Supply Chain Design [Ni Cening D - 29119098]

What is the time between orders?

𝑄 250
𝑇𝑖𝑚𝑒 𝑏𝑒𝑡𝑤𝑒𝑒𝑛 𝑜𝑟𝑑𝑒𝑟𝑠 = 𝑥 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 𝑝𝑒𝑟𝑦𝑒𝑎𝑟 = 𝑥250 = 𝟐𝟓 𝒅𝒂𝒚𝒔
𝐷 2500
What is the reorder point (ROP)?
The reorder point (ROP) is the level of inventory which triggers an action to replenish that
particular inventory stock. The calculation for the ROP is shown below:
𝐴𝑛𝑛𝑢𝑎𝑙 𝑑𝑒𝑚𝑎𝑛𝑑 2500
𝑅𝑒𝑜𝑟𝑑𝑒𝑟 𝑝𝑜𝑖𝑛𝑡 (𝑅𝑂𝑃) = 𝑥 𝐿𝑒𝑎𝑑𝑡𝑖𝑚𝑒 = 𝑥2 = 𝟐𝟎
𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝑑𝑎𝑦𝑠 250

2. Bolang tire center sells 20000 tires per year. The ordering cost for each order is $40 and
the holding cost is 20% of the purchase price of the tires per year. The purchase price is
$20 per tire if fewer than 500 tires are ordered, $18 per tire if 500 or more but fewer than
1000 tires are ordered, and $17 per tire if 1000 or more tires are ordered.
Sales (D) 20000
Ordering cost (K) 40
Holding cost 20% of purchase price

Quantity ordered
≤500 500>x>1000 ≥1000
Purchasing price 20 18 17
Holding cost (h) 4 3.6 3.4

How many tires should Bolang order each time it places an order?
Determining the number of tires that Bolang should order in every order placed is by finding
the value of EOQ. We need to take every possible option into consideration. Thus, every option
available would be explained in the Scenarios below.
Scenario A
In Scenario A, the purchase price that would be used is $20 per tire and fulfill the condition of
tires being ordered fewer than 500 each time order placed. Thus, the calculation of the EOQ is
shown below.

2𝐾𝐷 2(40)(20000)
𝐸𝑂𝑄𝐴 = 𝑄 ∗ = √ =√ = 632.45 ≈ 𝟔𝟑𝟑 𝒖𝒏𝒊𝒕
ℎ 4

From the result above, we could see that the 𝐸𝑂𝑄𝐴 is higher than 500 which does not fulfill the
requirement. Thus, for this scenario we would use 𝑸𝑨 = 500 unit for the future calculation.
Scenario B

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In Scenario B, the purchase price that would be used is $18 per tire and fulfill the condition of
tires being ordered is more than 500 but fewer than 1000 each time order placed. Thus, the
calculation of the EOQ is shown below.

2𝐾𝐷 2(40)(20000)
𝐸𝑂𝑄𝐵 = 𝑄 ∗ = √ =√ = 666.67 ≈ 𝟔𝟔𝟕 𝒖𝒏𝒊𝒕
ℎ 3.6

From the result above, we could see that the 𝐸𝑂𝑄𝐵 fulfills the requirement of order which more
than 500 but fewer than 1000. Thus, for this scenario we would use 𝑸𝑩 = 667 unit for the
future calculation.
Scenario C
In Scenario C, the purchase price that would be used is $20 per tire and fulfill the condition of
tires being ordered fewer than 500 each time order placed. Thus, the calculation of the EOQ is
shown below.

2𝐾𝐷 2(40)(20000)
𝐸𝑂𝑄𝐶 = 𝑄 ∗ = √ =√ = 685.99 ≈ 𝟔𝟖𝟔 𝒖𝒏𝒊𝒕
ℎ 3.4

From the result above, we could see that the 𝐸𝑂𝑄𝐶 is lower than 1000 which does not fulfill
the requirement. Thus, for this scenario we would use 𝑸𝑪 = 1000 unit for the future calculation.
What is the total cost of this policy?
The total cost of inventory is the sum of the purchase, ordering and holding costs, with the
formula as:
𝑇𝑜𝑡𝑎𝑙 𝑐𝑜𝑠𝑡 = 𝑃𝑢𝑟𝑐ℎ𝑎𝑠𝑒 𝑐𝑜𝑠𝑡 + 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝑐𝑜𝑠𝑡 + 𝐻𝑜𝑙𝑑𝑖𝑛𝑔 𝑐𝑜𝑠𝑡
Next, we will find the total cost of every scenario that previously stated with every data
collected. The calculation is shown below.
Purchase Holding Total orders Average Purchase Order Holding
EOQ Q Total cost
price cost (h) in a year inventory cost cost cost
Scenario A 20 4 633 500 40 250 400000 1600 1000 $402,600
Scenario B 18 3.6 667 667 30 333.5 360000 1200 1200.6 $362,400.6
Scenario C 17 3.4 686 1000 20 500 340000 800 1700 $342,500

From the calculation above, we could see that the scenario that give the lowest total cost is
Scenario C. Thus, it is suggested that Bolang should order 1000 tires each time the order placed,
which would generate the total cost for the year as much as $342,500.00.

3. 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.

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Mean lead time demand, normally distributed 60

Standard deviation of demand (𝝈𝒅𝑳𝑻 ) 7
Service level (SL) 90%

What safety stock level do you recommended for BX-5?

With the service level of 90%, we could find the Z value from standard normal table or z-table.
The Z value of SL = 90% is 1.29. Thus, the calculation of safety stock level is shown below.
𝑆𝑎𝑓𝑒𝑡𝑦 𝑠𝑡𝑜𝑐𝑘 = 𝑍𝜎𝑑𝐿𝑇 = (1.29)(7) = 9.03 ≈ 𝟏𝟎

What is the appropriate reorder point?

𝑅𝑂𝑃 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑒𝑚𝑎𝑛𝑑 𝑥 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒 + 𝑍𝜎𝑑𝐿𝑇 = 60 + 10 = 𝟕𝟎

4. GC stocks bicycles that have variable lead times because of the difficulty in importing the
product: lead time is normally distributed with an average of 6 weeks and a standard
deviation of 2 weeks. Demand is also variable and normally distributed with a mean of 200
cigars per week and a standard deviation of 25 cigars
Lead time, normally distributed (variable)
Average lead time 6 weeks
Standard deviation lead time (𝜎𝐿𝑇 ) 2 weeks
Demand, normally distributed (variable)
Average demand 200
Standard deviation demand (𝜎𝑑 ) 25

For a 90% service level, what is the ROP?

With the service level of 90%, we could find the z value from standard normal table or z-table.
The z value of SL = 90% is 1.29. Next the calculation of ROP is shown below.
𝑅𝑂𝑃 = (𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑎𝑖𝑙𝑦 𝑑𝑒𝑚𝑎𝑛𝑑 𝑥 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒) + 𝑍𝜎𝑑𝐿𝑇
With 𝑍𝜎𝑑𝐿𝑇 as a safety stock. The calculation for 𝑍𝜎𝑑𝐿𝑇 is shown below.
𝑆𝑎𝑓𝑒𝑡𝑦 𝑠𝑡𝑜𝑐𝑘 = 𝑍𝜎𝑑𝐿𝑇
= √(𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒 𝑥 𝜎𝑑 2 ) + (𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑎𝑖𝑙𝑦 𝑑𝑒𝑚𝑎𝑛𝑑)2 𝑥 𝜎𝐿𝑇 2
= √(6 𝑥252 ) + (200)2 𝑥22 = 404.66
Thus, the value of ROP is
𝑅𝑂𝑃 = (200 𝑥 6) + (1.29)(404.66) = 𝟏𝟕𝟐𝟑

What is the ROP for 95% service level?

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With the service level of 95%, we could find the z value from standard normal table or z-table.
The z value of SL = 95% is 1.65. Next the calculation of ROP is shown below.
𝑅𝑂𝑃 = (𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑎𝑖𝑙𝑦 𝑑𝑒𝑚𝑎𝑛𝑑 𝑥 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒) + 𝑍𝜎𝑑𝐿𝑇
With 𝑍𝜎𝑑𝐿𝑇 as a safety stock. The calculation for 𝑍𝜎𝑑𝐿𝑇 is shown below.
𝑆𝑎𝑓𝑒𝑡𝑦 𝑠𝑡𝑜𝑐𝑘 = 𝑍𝜎𝑑𝐿𝑇
= √(𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑙𝑒𝑎𝑑 𝑡𝑖𝑚𝑒 𝑥 𝜎𝑑 2 ) + (𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑑𝑎𝑖𝑙𝑦 𝑑𝑒𝑚𝑎𝑛𝑑)2 𝑥 𝜎𝐿𝑇 2
= √(6 𝑥252 ) + (200)2 𝑥22 = 404.66
Thus, the value of ROP is
𝑅𝑂𝑃 = (200 𝑥 6) + (1.65)(404.66) = 𝟏𝟖𝟔𝟖

Which service level is preferable, explain?

Determining the preferable service level (SL) is best if we first make a scenario of the
conditions that could picture the condition that could happen since both the lead time and
demand for this company is variable. The variability in lead time and demand would create
higher risk of stockout or the higher inventory cost if we fail to determine the best service level
and forecasting. As for this case to determine the service level, there would be a worse-case
and best-case of the lead time.
Safety stock Inventory (back order)
Demand Lead time Stock available SL=90% SL=95% SL=90% SL=95%
225 8 1800 1723 1868 (77) 68
worst-case
175 8 1400 1723 1868 323 468
225 4 900 1723 1868 823 968
best-case
175 4 700 1723 1868 1023 1168
Table above is illustrating how much loss sales would we got and the inventory that would
occur if we use the chosen service level. Next, some assumption would be made as to determine
which service level generates the most preferable condition. In this case, revenue would be the
base to determine. The assumption shown below.
Product price $20
Holding cost (h) $4
The sales would be counted by the multiplying of stock available and the product price if the
safety stock is higher. If it is not higher, the safety stock would be used. After that the revenue
would be generated by calculating the sales in both cases, minus both the loss sales and
inventory cost if presents. The calculation is shown in the table below.
Inventory cost Sales Revenue
Loss sales
SL=90% SL=95% SL=90% SL=95% SL=90% SL=95%
$ (1,540.00) - $ 272.00 $ 34,460.00 $ 36,000.00 $ 32,920.00 $ 35,728.00
worst-case
- $ 1,292.00 $ 1,872.00 $ 28,000.00 $ 28,000.00 $ 26,708.00 $ 26,128.00
- $ 3,292.00 $ 3,872.00 $ 18,000.00 $ 18,000.00 $ 14,708.00 $ 14,128.00
best-case
- $ 4,092.00 $ 4,672.00 $ 14,000.00 $ 14,000.00 $ 9,908.00 $ 9,328.00

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It is known that safety level is the trade of customer satisfaction level and the inventory cost.
The higher the level is, the higher inventory cost could be which also could be seen on the table
above. In this scenario the customer satisfaction is pictured in loss sales, if there is none than
it is fulfilled. Using the scenario above, we could see that in the worst-case where demand is
the highest and lead time is the latest, with service level of 90%, the company fail to fulfill the
demand happened during the replenishing time. Thus, portrayed with the service level of 95%
company could generate revenue higher than the service level of 90%. However, we should
also take into account of another case happened. By the table above, we could see that in the
most cases made, service level of 90% generates more revenue than service level of 95%. It
implies that the service level of 90% is quite enough, given the condition that company
faced (the variability of demand and lead time).

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