Solutions for Chapter 6

Problem 6.1
The data in the question is: flow rate R = 50,000 parts/yr, fixed ordering cost S =
$800, purchasing cost C = $4/part, and cost of capital r = 20%/yr. Thus, the annual
unit holding cost is H = rC = $0.8/yr. The economic order quantity tells us to
purchase each time
2 RS
2 50,000 800

H
0.8

a) Q =

= 10,000 units.

b) Order R/Q = 5 times per year.

Problem 6.2
BIM Computers: Assume 8 working hours per day.

We know Q = 4 wks supply = 1,600 units; R = 400 units/wk = 20,000

units/yr; purchase cost per unit C = $1250*80% = $1,000. Thus, holding
cost H = rC = 20%/year $1,000 = $200/yr. Switch over or setup cost S
= $2,000 + (1/2hr$1,500/day1day/8hr)= $2,093.75. Thus, # of setups
per year = R/Q = 20,000 units/yr / 1600 units/setup = 12.5 setups/yr.
Thus,
Annual setup cost = (R/Q) * S = 12.5 setups/yr
$2,093.75/setup = $26,172/yr.
Annual Purchasing Cost = R*C = 20,000 units/yr $1,000/unit =
$ 20 M/yr.
Annual Holding Cost = (Q/2) H = 800 $200/yr = $160,000/yr.
Thus, total annual production and inventory cost = $20,186,172.

2 RS
2 20000 2093.75

H
200
EOQ =

= 647 units.
number of setups = R/Q = 20,000 /647 = 30.91. Thus, annual
setup cost = 30.91setups/yr $2,093.75/setup = $64,718/yr.
annual holding cost = (Q/2) H = 323.5 $200/yr = $64,700/yr
(notice that at optimal EOQ annual holding cost equal setup
costs)
annual purchasing cost remains $20M/yr
The resulting annual savings equals $20,186,172 - $20,129,418
= $56,754.

Problem 6.3
Victor's data: flow unit = one dress, flow rate R = 30 units/wk, purchase cost C =
$150/unit, order lead time L = 2 weeks, fixed order cost S = $225, cost of capital r
= 20%/yr. Victor currently orders ten weeks supply at a time, hence Q = 10wks
30 units/wk = 300 units.
a. Costs for Victor's current inventory management:

Annual variable ordering (purchasing) cost = RC = $150/unit 30

units/wk 52 wks/yr = $234,000/yr.
Annual fixed ordering (setups) cost = (# of orders/yr) S = (R/Q) S =
(3052/yr/300) $225 = $1,170/yr.
Annual holding cost = H (Q/2) = (rC) (Q/2) = $30/yr 150 = $4,500/yr.
Total annual costs = $239,670.

b. To minimize costs, Victor should order in batches of

2 RS
2 30 52 225

H
30
Q* = EOQ =

= 153 units.

Thus, he should place an order for 153 units two weeks before he expects
to run out. That is, whenever current inventory drops to RL = 30
units/wk 2 wks = 60 units, which is the re-order point.
His annual cost will be

2 RSH 2 30 52 225 30
RC +

+ $234,000 = $4,589 + $234,000 = $238,589.

c. Inventory turns = R/I, where average inventory I = Q/2 with cycle stock only.

Current policy: turns = R/(Q/2)=2 R/Q = 2 30units/wk / 300units =

2/10week = 52 2/10 per year = 10.4 times per year.
Proposed policy: Q is roughly halved, so turns roughly double to 20.4 times
per year.

Problem 6.4
The retailer: Current fixed costs, S1 = $1000. Current optimal lot size Q1 = 400.
New, desired lot size Q2 = 50. We must find the fixed cost S2 at which Q2 is optimal.
Since Q1 is optimal for S1, we have

2 RS1
2 R 1000

H
H
Q1 = 400 =
Now,

. So, R/H = 160000/2000 = 80.

2 RS 2
H
Q2 = 50 =

or S2 = 502 /(280) = 15.625. So the retailer should try to reduce her fixed costs to
$15.625.

Problem 6.5
Major Airlines: This question illustrates the basic tradeoff between fixed and variable
costs in a service industry; thus the concepts of EOQ discussed in class in the
context of inventory management are much more generic.
The process view here is illuminating and it goes as follows: flow unit = one flight
attendant (FA). The process transforms an input (= "un-trained" FA) into an output
(= "quitted" FA). The sequence of activities is: undergo training for 6 weeks, go on
vacation for one week, wait in a buffer of "trained, but not assigned FA" until being
assigned, serve as a FA on flights, and finally quit the job.

Untrained
FA

Training
T = 6 wks

Vacation
1 wks

Pool of
trained FAs
? wks

R
Serve on flights

Quitted
FA

2 years

The question asks for the tradeoff between training costs (higher class size is
preferred) versus 'holding costs' in the buffer (smaller class size -> fewer attendants
waiting in buffer is preferred).

(a)

Flow rate R = 1000 every two years = 500 attendants per year = 10 per
week.
Fixed costs of training involves hiring ten instructors and support
personnel for 6 weeks. Thus, fixed costs of training S = 10 ($220+$80)
6 weeks = $18,000 per training session.
Annual holding cost is the cost incurred to hold one flow unit (FA) in the
buffer for one year: H = $500 per month 12 = $6,000 / person / year.
Thus, Economic Class Size (EOQ) = 54.77 or 55 per class. Thus, we should
run R/Q = 500 / 55 = 9.09 classes per year
Per person variable cost of training is the stipend paid for 6 weeks of
training + stipend for a week of vacation = $500/mo. perperson 7 wk
12 mo/yr / 50 wk/yr = $840 per person. Notice that the annual variable
cost is constant $840/person 500 person/yr = $420,000/yr regardless
of the class size.

Total Annual Cost = Fixed Costs of Training + Variable Costs of Training +

Holding Costs = ($18,000 9.09) + ($840 500) + (55/2)($6000) =
$748,636.36 per year.
Time Between starting consecutive classes (say, T) = Q/R = 5.5 weeks.
Thus, we will have two classes overlap for a 1/2 week (and thus we need
two sets of trainers and training class rooms). The inventory-time
diagram looks as follows (assuming for simplicity that we start the training
process at time 0):
I (in training)

110

55

Class 1
0

55

55

5.5

Class 2

Class 3

I (on vacation)
Class 1

t (weeks)
Class 2

Class 3

6 7

I (in buffer)
Class 1

6 7

t (weeks)

Class 2

Class 3

t (weeks)

(b): This part of the question illustrates the following: Often, in reality, people
wish to adopt policies that are simple (e.g., starting training every 6 weeks is
simpler than trying to track the exact days to start training when subsequent
trainings start every 5.5 weeks. But what is the implication of deviation from the
optimal? In this case, quite small. This is because the optimal cost structure near
the (optimal) EOQ is quite flat. Thus any solution close to optimality will suffice.
If time between classes (T = Q/R ) has to be 6 weeks, then Q = TR = 6
wks 10 attendants/wk = 60 attendants.
Total Cost of this policy = ($18,000)(500/60) + ($840)(500) + (60/2)
($6000) = $750,000 per year.

Problem 6.6
Fixed cost of filling an ATM m/c, S = $100.

To estimate demand, observe that the average size of each transaction = $80. With
150 transactions per week, annual demand R is estimated to be = 1505280 =
624,000.

With cost of money of 10%, unit holding cost, H = $0.10 / year

Then, the economic quantity to place in the ATM machine is given by the EOQ
formula:

Q=

2RS
2 624000 100
=
= 35,327
H
0.1

The number of times the ATM needs to be filled = R/Q = 624000/35327 = 17.66 per
year.
Problem 6.7
The annual demand, R = 150,000 lbs/yr. The purchase price per lb is $1.50.
However the shipping cost exhibits a quantity discount model. The holding cost per
year is then 15% of the sum of the purchase and shipping cost. The administrative
costs of placing an order = $50/order.
(a) In addition, rental cost of the forklift truck adds to the fixed cost giving a total
fixed cost, S = 50+350 = $400/order. We can use a spreadsheet model as
shown in Table TN 6.1. The optimal order quantity = 22,000 lbs with an
annual cost of $249,916.77.
(b) If GC buys a forklift and builds a new ramp, then the per-transaction fixed
cost will simply be the administrative cost of $50 per order. The economic
order quantity and annual operating costs of this option is shown in Table TN
6.2. The economic order quantity is 15000 lbs. with an annual operating cost
= $246,833.75. The annual savings = 249,916.77 - 246,833.75 = $3,083.02.
The net present value of cost savings (over 5 years) with cost of capital of
15% = $10,334.76. Assuming a useful life of 5 years for the forklift and ramp,
an investment of less than $10,334 generates a positive NPV.
Problem 6.8

Changeover time = 4hrs resulting in a fixed cost, S = 4 250 = $1,000.

Annual demand, R = 1000/mo 12 = 12,000 units / yr.
Unit cost, C = 100
Holding cost = $25 / unit / yr.
a) The optimal production batch size is

2 RS
2 12000 1000

980
H
25

b) To reduce batch size by a factor of 4, the setup cost needs to be reduced by a

factor of (4)2 = 16. That is, S should reduce to 1000/16 = $62.5. This
reduction can be achieved by reducing the changeover time or the cost per
unit time during changeovers.
Problem 6.9
a) From the EOQ formula, observe that the order quantity is proportional to the
square root of annual demand (R). Since cycle inventory is half of the order
quantity, it too is proportional to R. Since HP motors has a higher R, the cycle
inventory for HP motors is also higher.

R
b) Average time spent by a motor T = Icycle / R. Since Icycle is proportional to

R
T is proportional to 1/
. Therefore time spent by a HP motor is less than the
time spent by an LP motor.
Problem 6.10
Each retail outlet faces an annual demand, R = 4000/wk 50 = 200,000 per year.
The unit cost of the item, C = $200 / unit. The fixed order cost, S = $900. The unit
holding cost per year, H = 20 % 200 = $40 / unit / year.
a) The optimal order quantity for each outlet

2 RS
2 200000 900

3000
H
40

with a cycle inventory of 1500 units. The total cycle inventory across all four
outlets equals 6000 units.
b) With centralization of purchasing the fixed order cost, S = $1800. The
centralized order quantity is then,

2 RS
2 800000 1800

8485
H
40

and a cycle inventory of 4242.5 units.

Solutions for Chapter 7

Problem 7.1
[a]
Given quantities: mean weekly demand = 400; standard deviation of weekly demand =
125; replenishment lead time = 1 week and reorder point (ROP) = 500 units. We compute
the average demand during leadtime to be 400 units. Thus the safety stock, Isafety = 100
units; to find the service level provided, we need to find the area under the normal curve
to the left of the reorder point (ROP) = 500. Let the demand during lead time be LTD.
The cycle service level

Prob( LTD ROP) = Prob( LTD R + Isafety) = 0.7881.

[b]

So the cycle service level is 78.81%.

The standard deviation of lead time demand, LTD = 125 units. For each service level the
z-value can be read from the standard normal table. The safety inventory
Isafety = z x LTD Finally, ROP = 400 + Isafety.
Cycle Service Level
z=
Isafety =
ROP =

80%
0.842
105
505

90%
1.282
160
560

95%
1.645
205
605

99%
2.326
290
690

Problem 7.2
[a]
Average weekly demand (R) = 1000
Standard deviation of weekly demand (R) = 150.
L R
Lead time (L) = 4 weeks.
Standard deviation of demand during lead time (LTD ) =
= 300.
Current reorder point (ROP) = 4,200.
Average demand during lead time (LTD) = L x R= 4,000.
Current level of safety stock (Isafety)= 200.
Current order quantity (Q) = 20,000
Average inventory (I) = Isafety + Q/2 = 200 + (20,000/2) = 10,200.
H = rC = 0.25 x 9.99 = 2.4975 2.50
Average time in store (T) = I/R = 10,200/1,000 = 10.2 weeks.
Annual ordering cost = S x R/Q = $100 x 2.5 = $250.
Annual holding cost = H x I = 2.5 x 10,200 = $25,500.
[b]

We use the EOQ formula to determine the optimal order quantity.

H = $1 * 25%/year = $2.50/year
R = 1,000 /week = 50,000/year
S = $100.

2SR is
Thus, the economic order quantity

2 100 50, 000

4, 000, 000 2, 000
2.50

Q=

To determine the safety inventory, Isafety, for a 95% level of service, we first observe that
the z-value = 1.65. Then Isafety = z x LTD = 1.65 x 300 = 495.
Average inventory (I) = Isafety + Q/2 = 495 + (2,000/2) = 1,495.
Average time in store (T)= I/R = 1.495 weeks.
[c]

If lead time (L) reduces to 1 week, then standard deviation of demand during lead time
(LTD) = 150. Safety stock for 95% level of service = 1.65 x 150 = 247.5.
Average inventory = 247.5 + (2,000/2) = 1,247.5.
Average time in store = 1.25 weeks.

Problem 7.3
(a)

The optimal order quantity of planters for HG is

Q*

(b)

2 RS
2 1500 52 10000

24,980
H
2.5

If the delivery lead time from Italy is 4 weeks and HG wants to provide its customers a cycle
service level of 90%,

Safety stock = NORMSINV(.9)*sqrt(4)*800 = 2050

(c)

Quantify the impact of the change.

Additional transportation cost per year = 1500*52*.2 = $15,600
Savings in holding cost = NORMSINV(.9)*800*(sqrt(4)-sqrt(1))*10*0.25 = $2562.5
Thus Fastship should not be used.

(One could be more precise and compare the total costs under current shipping with that with Fastship. The latter
has slightly higher unit holding cost H, which also will slightly increase the cycle stock, in addition to the
transportation cost. Given that even at the old holding cost, transportation increased cost exceed holding cost
savings, the above answer is sufficient to draw the correct conclusion.)

Problem 7.4
First, is this an EOQ problem? Well, notice that the question dictates that we do a run
every two years. That would mean, in a deterministic EOQ setting, that Q must equal two
years of mean demand, i.e., 32000. Hence, this question does not give us the freedom to
change when we do a run (which is what EOQ is all about).
Thus, the question is whether 32000 is the best quantity we can print every two years?
This thus asks about what the appropriate safety stock (or service level) should be. We
know that this is answered by newsvendor logic. Answer these two questions:
1. What is my underage cost (cost of not having enough)? I.e., if I were to stock one
more unit, how much could I make? Every catalog fetches sales of $35.00 and
costs $5.00 to produce. Thus, the net marginal benefit of each additional unit
(MB), or the underage cost, is p c = $35 - $5= $30.
2. What is my overage cost? I.e., if I had stocked one less unit, how much could I have
saved? The net marginal cost of stocking an additional unit (MC) = c v = $5 0 = $5.

Now, we can figure out the optimal service level (or critical fractile): SL = 30/(30+5) =
0.857.
The last step is to convert the SL into a printing quantity. Recall that total average
demand for 2 years (R) = 32,000 with a standard deviation of 5656.86. The optimal
printing quantity, Q* is determined such that
MB
30

0.857
MB MC 30 5

Prob(R Q*) =
.

The optimal order quantity Q* = R + z where z is read off from the standard Normal
tables such that area to the left of z is 0.857. That is, z = 1.07. This gives Q* = 38,053
catalogs. It can be verified that the optimal expected profit (when using Q* = 38053) is
larger than $25,000, the fixed cost of producing the catalog.
Problem 7.5

The revenue per crate, p = $120.00, variable cost, c = $18.00, and salvage value, v = $2.00. The
marginal benefit of stocking an additional crate (MB) = p c = $120 $18 = $102. The marginal
cost of stocking an additional unit (MC) = c v = $18 + $2 = $20. Then
MB/(MB+MC) = 102/(102+20) = 0.836.
The probability density of demand and its cumulative probability is listed below.

Demand

10

11

12

13

14

15

Frequency

Prob.

0.02

0.06

0.04

0.1

0.02

0.12

0.13

0.12

0.15

0.1

0.08

0.02

0.06

0.02

0.08

0.12

0.21

0.23

0.35

0.48

0.6

0.75

0.85

0.92

0.94

Cumulative
Prob.

The optimal order quantity is the smallest number of crates such that cumulative probability is at
least 0.836. From the table this gives the number of crates to be 12.
Problem 7.6
How many crews should the city assign to trash collection? For simplicity, you may treat the
number of crews as a continuous variable. For example, 4.1 crews would be a perfectly acceptable
answer.
One solution approach (starting from the basics):
Note that the marginal cost of scheduling one more ton = $125/ton.
This only has value if demand exceeds current planned schedule, in which case it saves $650. In other
words, the expected marginal revenue is $650 Prob(R>Q).
At optimality, marginal cost equals marginal revenue:
Prob(R>Q) = 125/650 or SL = 525/650 = 80.77% z = .87 Q = 35 tons + .87*9 tons = 42.8 tons =
8.56 crews.
Another approach to get the critical fractile probability SL uses the newsvendor solution directly:
Here we are stocking up on local trash collection capacity.
Cost of overstocking by 1 ton = MC = 625/5 = $125
Cost of understocking by 1 ton = additional cost of using outside trash pick up = MB = $650-$125 =
$525
Thus: SL = Prob(RQ) = MB /( MB + MC) = 525/(125 + 525) = 0.8077
appropriate # of crews = 8.56 crews

Problem 7.7 (This is an advanced problem)

We are concerned about the overbooking problem; that is, how many seats to overbook. The
randomness in demand arises from uncertain cancellations, which are uniformly distributed
between 0 and 20. One can think of this question as asking what is the optimal service level of
cancellations?
If I overbook by 1 additional unit, then

If there are more cancellations than stocked, we are fine: there are sufficient seats for every
passenger who shows up. The net benefit is that we sold one more ticket at $600. (This is the
underage cost; i.e., cost of having more cancellations than stocked.)
If there are fewer cancellations than stocked, there are insufficient seats for those passengers
that have a ticket and show up. The net cost of this is that we must compensate the bumped
customer (who had a reservation but did not get a seat) by $250 (the $600 earned from the
additional ticket is spent on getting another ticket on another flight).

Thus optimal service level is MB/(MB+MC) = 600/(600+250) = 70%. The optimal overbooking
quantity is determined by Prob(RQ) = MB/(MB+MC) = 0.7. For uniform distribution between 0
and 20, Prob(RQ)=Q/20. Thus Q = 20 * 0.7 = 14 seats so that the optimal overbooking level is
14 seats.
Problem 7.8
[a] To compute the optimal order quantity at each store we use the EOQ formula.
Assume 50 sales weeks/year.
H = 25%/year * $10 = $2.5/year
R = 10,000 /week = 500,000/year
2 RS
2 500,000 1000
S = $1000. Thus,

2.5

Q = EOQ =

= 20,000 units.

The replenishment lead time (L) = 1 week.

Standard deviation of demand during lead time at each store (LTD) = 2,000.
Safety stock at each store for 95% level of service (Is) = 1.65 x 2,000 = 3,300.
Reorder point (ROP)= + Is = 10,000 + 3,300 = 13,300.
Average inventory across four stores (Id)
= 4 x (Is + Q/2) = 4*(3,300+(20,000/2)) = 53,200.
Annual order cost for all four stores = 4 x S x R/Q = 4 x 1,000 x25= $100,000.
Annual holding cost for all four stores = H x Id = $133,000.
Average time unit spends in store (T) = Id / 4 x R = 53,200/40,000 = 1.33 weeks.
[b] To compute the optimal order quantity at centralized store observe that this store
faces a cumulative average weekly demand = 4 x 10,000 = 40,000. This gives an annual
demand of 2,000,000 units. 2 RS 2 2,000,000 1000
H

Q = EOQ =

2 .5

= 40,000 units.

Standard deviation of demand during lead time at central store (LTD)

4 2000
=
= 4,000.
Safety stock at central store for 95% level of service = 1.65 x 4,000 = 6,600.
Reorder point (ROP) = 40,000 + 6,600 = 46,600.
Average inventory in central store (Ic) = 6,600+(40,000/2) = 26,600.
Annual order cost for central store = S x R/Q = $1,000 x 50 = $50,000.
Annual holding cost for central store = H x Ic = $66,500.
Average time unit spends in store (T) = Ic / 4 x R = 26,600/40,000 = 0.67 week .
Problem 7.9

(a) Given that each outlet orders independently and gets its own delivery, the optimal order size
at each outlet is
sqrt(2RS/H) = sqrt(2*4000*50*900/(.20*200)) = 3,000
Average cycle stock at each outlet = Q/2 = 1,500. Total cycle stock (and hence average
inventory) across all outlets = 4 1,500 = 6,000.
(b) On average, each unit spends
T = I / R = (Q/2) / R = 1,500 / 4000 weeks = 3/8 weeks = .375 weeks in the Hi-Tek system
before being sold
(c) With a fixed cost of $1,800, the new order quantity with centralized purchasing is
Q = (2x4,000x4x50x1800)/40 = 8,486
This quantity is split into four and shipped to each outlet. So each outlet received 8,486/4=
2,122 units per shipment (rounded up to make whole number of units). So cycle stock at each
outlet is 2,122/2 = 1,061 units.
Total average inventory across all four outlets will be four times the cycle stock in each outlet
= 41,061 = 4,244.
Problem 7.10
Mean demand, 1000/day with a daily standard deviation 150.
Annual unit holding cost, H = 0.25$20/unit/year = $5.00 / unit /year.
Review period, T = 2 weeks and replenishment leadtime, L = 1 week.
a) Average weekly demand, R = 71000 = 7,000; weekly standard deviation of demand =

s R = 7 150 = 397
Standard deviation of demand during review period and replenishment leadtime

s RLT D = ( Tr + L )s R = 3 397 = 688

For a 98% service level z = NORMSINV (0.98) = 2.054 and safety stock

I safety = z s RLTD = 2.054 688 = 1413

OUL = R(Tr+L) + Isafety=70003+1413=22,413 units
Average order quantity, Q = R Tr = 14,000 and therefore cycle stock = 14,000/2 = 7,000.
Average inventory, I = Q/2 + Isafety=7,000+1,413 = 8,413.
Total average annual holding cost = HI = 5.00 8,413 = $42,065 per unit per year.
b) If review period, T, is reduced 1 week, then,
Standard deviation of demand during review period and replenishment leadtime

s RLT D = ( Tr + L )s R = 2 397 = 562

For a 98% service level z = NORMSINV (0.98) = 2.054 and safety stock

I safety = z s RLTD = 2.054 562 = 1154

OUL = R(Tr+L) + Isafety=70002+1154=15,154 units
Average order quantity, Q = RTr = 7,000 and therefore cycle stock = 7,000/2 = 3,500.
Average inventory, I = Q/2 + Isafety=3,500+1,154 = 4,654.
Total average annual holding cost = HI = 5.00 4,654 = $23,720 per unit per year.
Total savings in holding costs =$ 42,065 $2327 = $18,795 per year.
Of course, now we order twice as frequently. So any associated costs related to placing orders needs to be
balanced off against the savings in inventory holding costs of a shorter review period.
Problem 7.11
[Same data as in Problem 7.8 but with periodic review]
Review period length Tr = 2 weeks
[a]

Assume 50 sales weeks/year.

H = $10 * 25%/year = $2.5/year
R = 10,000 /week = 500,000/year
Review period, Tr = 2 weeks
So, average order quantity Q = RTr = 10,0002 = 20,000 units
The replenishment lead time (L) = 1 week.
Standard deviation of demand during review period and lead time at each store.

s RLTD = ( Tr + L )s R = 3 2000 = 3464.1

Safety stock at each store for 95% level of service (Isafety) = 1.65 x 3464.1 = 5,716.
Order Upto level (OUL) = 30,000 + 5,716 = 35,716.
Average inventory across four stores
= 4 x (Isafety + Q/2) = 4*(5,716+10,000) = 62,864
Annual holding cost for all four stores = $2.5 * 62,864 = $157,160.
Average time unit spends in store (T) = (5,716+10,000)/10,000 = 1.57 weeks.
[b] To compute the optimal order quantity at centralized store observe that this store
faces a cumulative average weekly demand = 4 x 10,000 = 40,000.
Standard deviation of demand during lead time at central store ()
=

4 2000

= 4,000.

Assume review period and lead time remain same as before at 2 weeks and 1 week respectively.
So, average order quantity Q = RTr = 10,0002 = 20,000 units
Standard deviation of demand during review period and lead time at central store.

s RLT D = ( Tr + L )s R = 3 4000 = 6928.3

Safety stock at central store for 95% level of service (Isafety) = 1.65 x 6928.3 = 11,432.
Order Upto level (OUL) = 30,000 + 11432 = 41,432.
Average inventory at central store = (Isafety + Q/2) = 11,432+10,000 = 21,432
Annual holding cost at central stores = $2.5 * 21,432 = $53,580.
Average time unit spends in store (T) = (11,321+10,000)/40,000 = 0.533 week .