CHAPTER OVERVIEW'
CHAPTER
9 1
Tiic cnicient management of inventoric~ is a very
impur1anl factor in the ~uccessful functioning
of manulacturing and retailing organisations.
Under,landahly, since inventories require
invcs1111cnt of funds, the re are pai nfu l
implications of over-stocking as also of under-
! stocking. There arc many facets of inventory
management. Among the questions that will he
answered in this chapter arc the following:
I D What dues inventory mean and what are the
different types of inventories?
D Whal inventory decisions are to be taken and
what arc the costs involved?
ID What arc the inventory management systems?
D When the purchases should he made-what
1 D What arc the different bases, like usage.
should be the timing of purchases? In other
Inventory word~. should the purchases be made
~ j periodically at fixed intervals or as soon as
Management 'I
the stock level reaches a pre-determined
level?
, D What inventory models are available to
handle different situations? In particular, what
quantity should be ordered every time that a
purchase is made when:
Only one price rules for all order sizes and
no discounts arc avai lahle on large-sized
orders?
- --- ------
--------------- ----
One or murc price curs arc availahlc on
big orders~
The item is not pun;hased from out~ide
suppli ers and is instead produced
internally hy a sister dcpanment?
Back-ordering is possirlc so that order,
arc recorded when out-of-stock
conditions exist and arc supplied when
the purchased lot arrives?
D What is safetly stock and how is the level
of safety ~luck to be kept dctcnnined taking
due consideration of unccnainty of supply
time. the rate of demand and the costs
involved in being out-of-stock?
'I
cost, seasonality, etc., on which inventories
may be classified, so as to exercise a better
control over them?
This chapter involves a good amount of
calculation work and numerous formulae.
Understanding the derivation of cost functions
in respect of different modeb is important for
this chapter. Besides. knowledge of nonnal
distribution and calculation of areas under the
normal curve i; required. The derivations given
in the appendix require an understanding of
one-variable and more-than-one-vari able
differential calculus.
I I
I
I
444 Quantitative Techn~ifqu~e:s:_:1n~M~a!;na5g~e
~ ~m~e~n~t- - - - - - - - - - - - - - - - - - - - . _ _ . . , -- Inventory Management 445
ds demanded may be fulfilled as soon as then t h.
goo . ex s 1pment ofth .

~ 9.1
t and the demand might be lost forever leading tot e item(s) ts received) while in others it is
no emporary/permanent I Of
INTRODUCTION . almost inevitable.: to keep buffer stocks for the s oss customer goodwill.
~ It 1s 1111P1e reason tha r
. . f cturing and retailing organisations. They may . is an exception rather than the rule. We shall dis t per,ect prediction of demand and lead
ume . cuss Iater how th .
lnventories are vital to the success fu l ~unct1onmg -~-' of manu wnables.
a d goods. 1t 1s not necessan.
and fimshe held can be detcnrnned. e optimum level of the buffer stocks to be
. spare pan_.,,cons . . ,
consist of raw materials. work-in-progress. B whatever may be the inventory items, they need
. . h ntory classes. ut. . . (C) Anticipation Inventories Anticipation inventorie h
that an orgamsauon has a11 t ese mve . f t funds is invested 111 t11em. . . s are e1d for the re h ,
. II a substanttal share o t s . oduct is ant1c1pated. Production of specialised items l"k ason t at a JUture demand for the
etTtc1ent management as. genera Y, . . d dffercnt attitudes towards 111ventory. This is mainl pr t e crackers well befo o 1- b
. h. h , orgamsat1on a opt 1 , . Y ts before rains set in, fans while summers are approach .. re iwa t, um rellas and rain-
Different departments wit 111 t c samt d rtmcnt inCTuence the department s mottvation coa mg,orthep1ltngupof k h .
f erformcd by a epa . on the anvil, are all examples of anticipation inventories Th d . . mventory stoc s w en a smke
because the particular uncttons P . tock in reserve to meet virtually every demand that 1s e un erlymg idea is to s ooth h d
I d artn nt might desire 1arge s . cess for a longer duration on a continuous scale rather tha . . m en t e pro uct1on
For example, the sa es ep ie . . Id k for large stocks of matcnals so that the production Pro . n operatmg with excess
Th d d artment s1m1\ar\y wou as nd then letting the system be idle or closing down for the reaso f . d tve oventme in one penod
comes. e pro uctton ep d h ti nee department would always argue for a minimum
system runs uninterrupted. On the 0ther han t ed t~a here for other better purposes.
a
n ma equate/no demand for another period.
investment in stocks so that the funds could be use e sew (d) Decoupling Inventories
.
The idea of the decoupling invent . d
.
. .
ones 1s to ecouple, or disengage, d1 fferent
Parts of the productwn system. As we can observe easily different h. .
. , mac mes1equipment and people normally

~ 9.2
work at different rates-some slower and some faster. A machine for . h b .
. . . . , examp1e, m1g t e producmg half the
TYPES OF INVENTORY output of the mach111e on which the item be111g handled is to be processed th . .
. . . e next. 1nventones m between the
various mach111es arc held 111 order to disengage the processing on those mach th b f
. . mes. 1n e a sence o such
may be heId ,or ~ 1y of Purposes, but, in general, there are five types of inventories that an inventories, different machmes and people cannot work simultaneously on a conrinuous basis. When such
lnventones a vane
organisation can use for serving these purposes. These are: inventories are held, then, even if a machine breaks down, the work on others would not stop.
(a) Movement inventories; Indeed, if all the machines and people work at the same rate (a rare case, of course) then there would be no
(b) Buffer inventories: need for such inventories. But then, in that case if a machine breaks down, very soon the entire work might
(c) Anticipation inventories: come to a standstill.
(d) Decoupling inventories; and Clearly, therefore, the decoupling inventories act as shock absorbers and have a cushioning effect in the face of
(e) Cycle inventories. varying work-rates, and machine breakdowns and failures, and so on.
We shall consider these now. (e) Cycle Inventories Cycle inventories arc held for the reason that purchases are usually made in lots
(a) Movement Inventories Movement inventories are also called transit or pipeline inventories. Their rather than for the exact amounts which may be needed at a point o(time. Of course, if all purchases are made
existence owes to the fact that transportation time is involved in transferring substantial amounts of resources. exactly as and when the item is required, there would be no cycle inventories. But, practically, then the cost
For example, when coal is transported from the coal fields to an industrial town by trains, th_en t~e coal, while involved in obtaining the items would be very large.
in the transit, cannot provide any service to the customers for power generation or for bum111g 111 furnaces.
As the cycle inventories are related to the purchases in lots, they are also called lot-size inventories and,
(b) Buffer Inventories Buffer inventories are held to protect against the uncertainties of demand 3nd obviously, the larger the lot-size the greater would be the level of cycle inventories.
supply. An organisation generally knows the average demand for various items that it needs. However,_lhe
actual demand may not exactly match the average and could well exceed it. To meet this kind of a s_ituauon, 9.2.1
inventories may be held in excess of the average or expected demand. Similarly, the average delivery um~(th
is, the time elapsing between placing an order and having the goods in stock ready for use, and technical Y
t Inventory Decisions

In an inve~tory control situation, there are three basic questions to be answered. They are:
called as the lead time) may be known. But unpredictable events could cause the actual delivery ttme to:
more than the average. Thus, excess stocks might be kept in order to meet the demand during the time or (a) How much to order? That is to say, what is the optimal quantity of an item that should be ordered
which the delivery is delayed. These inventories which are in excess of those necessary just tu meet the aver~ whenever an order is placed?
age demand (during the average lead time period), held for protecting against the fluctuations in demand an
(b) When should the order be placed?
lead time are known also by the term safety stocks.
the (c) How much safety stock should be kept? Thus, what quantity of an _ite_m in_e~cess of the expected
The idea of keeping buffer stocks is to render a higher level of customer service and consequently reduce
number of stockouts and back-orders. A stockout occurs when a customer is denied fd fi lment of an er

rd
the order for
requirements should be held as buffer stock in anticipation of the vanauons m its demand and/or the
because the mventory Of t he ttem
(s) has runout. ln some s1
tuat1
.ons back-ordering is possible (1.e. time involved in acquiri ng fresh supplies?
 QualllltDllvt T~chmques in Managernenl

9.2.2 Inventory Costs

- have
-ses.~ the co~t, m1.-olvc<l
to as
t,ouuht
c-
.
111 lenn, of the profit on pot~ I I
.
III all future pen~ m ca\C he decides not to I

on and w forth. Such cost, can oc c:rnrh1tant indeed.
Inventory Management

um tot hc organ1sauon
441

lla sa c:s lost. profit on whatever the customer would

. for anyth mg m future, and so
1, .:
I.
Ii

. le most often is the cost function TT1e clas~1cal invcn-

p
th 00 '
ln det=mmg an opumal imentory policy. c en n d the ~tructu~ of .111 1mentory s1t l ti
tc,n analvs,s idenufics four maJor co~t components. Dcpcn mg on uatton,
~c. Of _all. ofthe.;e are included tn the obJective funcnon 9,3 INVENTORY MANAGEMENT SYSTEMS
ost of im entorv It 1~ the p,mhaH' price forth~ Hems that ....
I. Purebase COsl This refer.. to thc nomma / C -~
.,,.,,.A,,,..flon cost 1f the items arc produced "t1h111 the o~am-.ation. lnis
bought from outs1de M>urces. and the 1n .,.._ rod cd d Ba.~icolly. there arc two tn\'cntory management ,ystcm~. They arc
. L. uantl)'
1 ... ,rcha,'ledip uc mrrca.~ or <.'Crca...cs f\..
ma) be constant per umt. or 11 mll)' vary ru. Inc q ..- . '<"'llt
often. situations are found when 1l may be stipulated that. foreumple. the untt pmc I~ R, 20 for an ordcrupto (a) Fi.red ord,r quantify H'Item, or !he re-order point ,yflem. m \\ h1ch a level called the ,-,-order /e1el 1s
dctennrncd A~ "'1011 a, the ~lock level rcache~ th1\ pomt. an order for a prcdetem11ncd numocr of
100 un1Ls and R~ 19.50 1fthc order 1s for more than 100 units
units 11 placed
If the umt cost is constant.. 11 ~ not affect the inventory control d1s1(ms bc..ausc: then whether all the
tb) Periodic redew n'flem. "'here !he inventories arc replenished al fixed mterval~ of time Whcrca~ the
rtqul.fements arc bou~ht tproduccd) Just once. or whc:tM lhcy arc obtained m mstalnimts. the t(lllll amount of
si1c of order 1, fi11cd m the prev10u~ ~y~tem and the time is not. m tl11s ,y,tem the time ofter which 1he
money in,olved would be the~. However. we do cons1dcr lhc quanlll) d,~--..,unts "hen they oc,ur. because
supphc~ arc ordered 15 fixed but not the quantity to be ordered.
the) affect these dcc1s1ons.
There i-. another \y~tem. called the S, system, "hich combmes the feature, of both of these
2. Ordering cost/Set-up Cost Ordering cost is l1lCUJ1t'd whenever the mventor) 1s replcmshcd. It ID-
We shall d1.,cus.~ the three \y~cms m tum.
eludes costs as.~'IC'tated w1th lhc processing and chasm8 of the pure~ ordcf. transponat1on. inspection for
quahty. cxpcd1tmg overdue ordcn, and so on. It "' also kno,r,1l as the prooucment co.,,
~ parallel of the onlcnn.g ~'\'ISi when umts arc produced'\\ithin the ocgamsahon is the set-up, '(I.fl. It refers to ~ 9.4 FIXED-ORDER QUANTITY SYSTEM
the cost incurrtd in relation to de\cloping the production schedules. the re-;oun.~ employed m making the
prod1K'tion system ready, and 'Ill on. The fixed-order quanhty sy~tcm of in,cntory management is also called the Q-.,y.dem. A~ ix11nlcJ out earlier,
The ordering (and set up) co~'t 1s hkcly. and taken, to he tndq,cndent of the ordcf stz.e. Therefore. the unit under this system a re-order point 1s estabhshed and a., !,()(JO a.~ the ~tock level reachc<J th,~ point. a frc,h order
orocring/sct-up cost dhllC'S as the purchase onkrlproduction run increases in sir.c. for supplies is triggcrcd. We shall con.~idcr this system under condition, ofcertainty (i.e. when the demand and
the lead tune are known with cenainiy) and then e,tend it to the probabilimic condition., when demand and/or
3. carrytng cost Also ln0'\\1l as the ltoldiltgCOJ1 octhestonzgrcost, carrying cost represents the cost thal
lead time arc uncet1ain. Four models, hascd on ,wymg undcrlymg conditions shall be developed to study the
IS ISSOCiated w1th ,torin.g an llffll in in\lC'!ltory. It IS propo,tional to the amount of inventory and the time OVfl
operation.~ of the system under dctemtm,suc cond1riom.
which 1'. is held Tot_ el=ts of carrying cost include 1hc opponunity c05t ofcapital invested in the stoek; tbe
c~ts dll'CCtly a.~iatro ~ stor111g good$ (like stomncn's salary, rates, heating and hghting. raektnl and
p(lkt1sauon.
. protectwc clothtng. store's ,...n.......,
"--r"' Cle) . , ,.,_ uv:iu,,,,,,.-~~
u..- -"--t... ' lud mg !!Cnpprng zuiu
- - cost ( me --"..,,..
r-
Model 1: The Classical EOQ Model
siblce rework): detcnor.bon costs and ~ 1ncurml 1r1 Jl"'YCftbno detcrion nd fi and en! insur-
ance. etc ..., uons; a ire 11cn To bcain wtth, we shall dewlop the classical m,no111ic ortkr quandlv ""'*1 ( EOQ model) al10 known as the
Wilso~ formulation., which 1s the mos1 clemeolary ofall tho Ulwntmy models This model "an
analytical one. ! I 1
lbc: call) llli COSI IS U.Sually C.\pres,cd ti a ra1r
'
JlCf unn 11$ pm;.cniagc of the mvcnlOry value It " taken
For this, first cost model is dc,-clopcd and thi ,1 ts manq,wau,d to form an mvenso,y model.
to he fh:cd for each unit of a cenaan nan or m'l-'UI....., L-ld r An unipthlns The model II ha.~ on the foUowma butc imumprnn
- r "" Of a um1 tune.
4. Stockout COst Stock.out rou mans lbe llOlt (a) The demand for the ,tern is ccnam, con11nuous and comwit over llnM.
lobor1ap. lftbc: slockout is intffl\11 (lhat "-IllthcISSOc\ltcd 111th not lC'1'V1n11 the cUSlornrn.. S1ockouta ,mply !b) The lead ttme, that 15 1hc 11mc bct"c,cn plkmJ an onkr and 11.a lkhvtry. 11 known and flxC!d. ThUI.
lo5t. raultina in idle ti~ for men and mac~ : t , u n ystem) 11" 'oold imply 1h01o;ornc producuon ts '4 hen the lead tirm is n-ro 1hc Jchvcrv of 11cm 11 1nl&alltaMt>U!I
"111k 1fthe sux:kout isexlomal. 11 would n:sult ioa l the '40!'\. tjJclayed '\\h1ch m1gh1 ut1ra1:t 11C>mc pcnAIIY (c) W11hm the rnnie of the quanuucs to~ onkrtd. lhc per uni! holdma co1t and the: ordcnna cost (p
~ am e-voke dttTercnt rcecuoas from ou of l'(lt(nhal lo&!<". and ot l(.ll\\ of customl'f 11oocJwill. A d 0 nler) arc con~t nt and thus 1ndependc:nt of the quantll) ClfJe-red
bkooicr the ..ie. att 00 . t lost. ..,_, __ ~ - 11 '-ould l"NUlt III a bad,or<kr or a 10 ,1 ..ale,. In case of ( I The purduuc pnct' of rhc ucm i~ con.cant. that 1 to la)', TI<' d111Coont a,11,lablt on J"ll'Chun
~~ Oil,, - .. ~ When the ..
denied carhcr '""'1d he 1mJT1cdiately iu11t1hcd the ~ of IIIJC lots
M ... ,

""' llb.lpmcn1 mu. m11omer who

11
--1. mayt,c. abo pecli.a,ma and shtpmcnt ,(-.u On lilC llU1 -.uuld 111vol~ c..,,11s hk.c thollc of exp(dluni (e) In c mventory I\ replcmAhcd immcdi-'y u tht ud l~eJ rac:hca n1ctly 1:q11&I to ,on Con,e-
Od'Cf '-111. -.hen \he saJc- an: loll fon:vef, ti ti diflicuJI quemly. thn-c are oo ,tock oVfftPI Of thunl,e-
448 Quan titative Techniques in Management

With this set of assumptions. the inventory !eve1wou

Id vary over time as depicted in Figure 9. I.
_
---1'!1~
dO'I - :===-~~- - - - - - -~Jn~v::en~t~o~ry~
Easton Electronics Co prOduces
of tubes of a certain type. Each tube costs Rs 1O .
2 000
TV .
M~a
. ~n~a~g;'.em
~ en~t~ -44
sets in a year for which 11
~ 9
d
and the cost nee s an equal number
Besides, th e cos t o f Pa
I cing an order is Rs
150, wh.1ch 1 . 1o hold a tube in stock f .
Maximum s not related . . or a year 1s Rs 2.40.
- Q - - - stock level Now if an order for 2,000 tubes is placed only to its size.
~ . , one order per a .
21 Average Inventory tor 2 orders in a year are needed, while if 500 u .1 nnum 1s required. When 1 000 ts
d
level, Q/2 an~um are required. Naturally, as the number o,n' sdare ordered to be supplied then ~ tota~nif 4are ordered
. or ers placed o orders per
_/ _ orders, however, wou Id aIso imply smaller order q
ff b tw
.
have a trade-o e een the ordering and the hold.
.
uant1ty and the f
'
increases the ordering cost
goes up. More
re ore, decreasing holding co t Th
Av 1-------- . . . . ing cost. What . s s. us, we
the order size that m1nim1ses the cost function T (Q) we attempt in our EOQ mOdel is th t ti
. , en, o ind
R -------- - -----, -- --- - -- -- -- - -------: -- - -- -- - ---- , - -- ----- Let us consider for our illustration the computati . .
on m a step-wise function
: Reorder level
(a) Total Annual Ordering Cost This is given b h .
'' ( ) Yt e number oft1m d
nme
the ordenng or acquis1t1on cost per order, A. Thus, es an or er 1s placed, N, multiplied by
0
A,+ LT+ T, :8 T2
I+ - - - - T ____...
O (Q) = Nx A
The value of N itself is dependent on the order quanf1ty Q
Figure 9.1 Inventory Profile of Classical EOQ Model to D!Q. Accordingly, ' and the annual demand, D. Here N would be equa l

Suppose that we begin with a stock of Q on the time? This will ~e c~nsumed at the rate of d units per day, say. O(Q) = _QA
If the stock can be replenished instantaneously, that 1s, the lead lime 1s zero. then a fresh order would be made Q
and the inventory obtained at point T1. Similarly, when this stock is consumed, an order woul d be made at point For our example, when
T2 . On the other hand, if the lead time is positive, equal to LT, we would place an order at point A, i.e. when we N = 1, Q = 2,000
have in stock an amount equal to the demand during the lead time so that we would have consumed it by the and O (Q) =Ix 150 = Rs 150,
time the fresh delivery is due to arrive. This is called the re-order level, or the reorder point, R . N= 2, Q = 1,000
and O (Q) = 2 x 150 = Rs 300,
The interval between two successive points when orders are placed (for example A and B ), or the time elapsed N= 4, Q = 500
and O (Q) = 4 x 150 = Rs 600.
in consuming the entire lot of items received, Q, is called the inventory cycle. It is represented in the Figure 9.1 5
. . N = , Q = 400 and O (Q) = 5 x 150 = Rs 750.
by T. The maximum inventory held would be Q while the minimum be zero, and hence the average inventory
Figure 9.2 depicts the total ordering cost The la h .
level would equal Q/2. vice versa. rger t e ord er quantity, the smaller the tota l ordering cost, and
Because of the first and the second assumptions, there is no need for maintaining a safety stock. Also, because
of the first assumption, the inventory decision, as to when to order, is completely specifi ed when the quantity (b) Total Annual Holding Cos t The total annual h . . .
to order is known. Therefore, the basic issue to settle is the determination of the order quantity, Q. cost (measured as rupees per unit er ann oldmg cost is obtamed by multiplying the unit holding
For determining the optimum order quantity, we shall consider two types of costs, viz. the ordering and the been pointed out earlier the ave p . um), h, by the average number of units held in the inventory As has
holding cosL Since the purchase price of the units is uniform (assumption d ), it does not affect the decision as tory, per annum would be: rage mventory held equals Q/2. Consequently, the total cost ofholdin~ inven-
to the quantity of the item to be ordered for purchase and, hence, is irrelevant for the purpose.
According to this, our cost model would, assum ing a period of one year, be H (Q)= 2._ h
2
For our example, when
T (Q) = 0 (Q) + H (Q)
where,
2
Q = 2 ,000, H (Q) = ,000 X 2.40 = Rs 2 400
Q = the ordering quantity 2 ' '
T (Q) = total (variable) ann ual inventory cost Q = 1,000, H(Q) = l,OOO x 2.40 = Rs I 200
2 ' '
0 (Q) = total annual ordering cost
5
H (Q) = tota l annual holding cost Q = 500, H (Q) = 00 X 2.40 = Rs 600
2 '
Let us develop the model with the fiollowingexamp1e. 400
Q = 400, H (Q) = - X 2.40 = Rs 480
2 .
 .....

450 Quantitative Techniques in Management - ---- Inventory Ma11age111e111 451

. 10 the order quantity. This is displayed in F' ure 9.2. the total cost curve is obtained by addin th
Obviously. the total holding cost varies in direct proporuon In. ig n this curve would determine the optimal qm1g. c tlwo .components O(Q) and fl(Q). The minimum
n1ny, t 1e Econom. 1c o rtcr
Figure 9 .2 . given
stion, more o flc,,
1h1s quc. Point obe placed each lime.
. . .
rh1s would ensure minimis8 t' f
I Q . .
uant1ty (Q) for which an
. nventory 1s 10 order . . ion o the total cost.
fh 1dngau01tman1
It may be pointed out that altl1ough the cost O O
I
f the value of inventory. It may be stated for ex. the figure. 1t 1s clear that the total cost is minim
from . Q w1icn Q 500 I . I ,.
the holding cost is expressed as a proportion, or percentagefoh alue of an item. It implies that if an item costs 9 1 Therefore, EO . also represented as Q. is cq um 0{ .
1
um s, as a so 1s c car rom the
. d. 15o/cO per annum o t e v . . I
Tob e uu 1to 5 J unns It muy r rtl b d h 11 d
ample. that the inventory hol mg costs arc tnit per year. Thus, 1f i 1s the proportion (or the holding and ordering costs arc also cquul. From the tnbl, : . u 1cr c note I at at t 1s or er
40 6 levc1 . c, we notice that cuch of these equals Rs 600.
Rs 40, then the holding cost would be 15% of Rs : Rs. tlpenost of the item then unit hold mg cost I, "' ,c hic and tabulation methods of delcrmining the EOQ .
.
percentage), which 1s also known as the hoId 1ng ra e.
t and C IS 1e C ' ' The grap . arc qu11c cumbcrsom , W b h . I
. h following formulation (sec appendix to th'. h . . c. c can o tam t 1s vu uc
th the cost components can now be added up und we can using t c is e apter, 9A, for Its denvution):
(c) Total (Variable) Annual Inventory CoS t Bo d uantities arc given in Table 9 1
obtain the total cost of inventory. The calculations for some or er q
Q* = (2AD or Q* "'
VI , J 2
AD (where the hOId'
ic
. . .
mg cost is given 1s given as a proportion)

for Example 9. 1. we huvc A ~ Rs 150 per order, h "' Rs 2.40 per unit per annum, D"' 2,000 units. ~hus,
TABLE 9.1 Calculation ofTotal Cost
Annual Ordering Cosl Annual Holding Cost Toto/ A11111w l Cost Q = 2 X 150 X 2,000
Order Quantity
3,120 2.40
3,000 120
100
240 1,740 = Ji.so.ooo = 500 units
200 1,500
480 1,230 It is the same as obtained earlier.
400 750
600 1,200 Determination of the Re-order Level The re-order level would be established at a point such that the
500 600
1,200 1.500 stock in hand would be just sufficient to meet the demand during the lead time. Suppose 1ha1 for the TV
1,000 300
2.550
' example, the following additional data are given:
2,000 150 2,400
No. of working day s m the year - 250
Lead time "' 15 working days
Cost (Rs) With this information, the daily demand = 2,000/250 = 8 tubes
2~00 Demand during lead time = 15 x 8 = 120 tubes
:. Re-ortler level = 120 tubes
2000
Other Information In addition to the optimal order quantity and tl1e re.order level. we can have !he follow-
ing information:
1600
(a) Annual Total Variable Inventory Cost The minimum annual inventory cost can be determined
by substituting Q for Q in the cost equation. Thus,
1200
ii T(Q") = ..JLA+~h
Q 2
800

400
Ordering Cost DA
= ---+
(1)h
0
J2~ 2

1400 1600 On simplification,

Order size T(Q) = J2ADh
For our example
Figure 9.2 Graphic Determinaiion of EOQ T(Q*) = J2 x 150 x 2,000 x 2.4-0
= J 14,4-0,000 = Rs 1,200
 :4.:S:2__JQu~a;:n'.'.:11~t~a~11~v:e2T,~e:ch~n'.'.:1~q~u=es~in'._:M.~a~na~g!'.e~n~1e~n~1- _ _ _ _ _ _ _ _ _ _ __ _ _ __ _
___ ..-------------:-==-=---~----------~ln~v~e~n~to~ry~M~a~n~a~g~e~m
~e~n~t-~4~S~3
h proportion form. we have. Annua l demand = Rs 20,000
It may be noted that when the holding cost is expressed m I e
Ordering cost
= Rs 150 per order
T(Q*) = JfADic .
. r,l tant demand D and the economic order quantity Q th Inventory carrying cost - 24 .0
of average inventory value
. , d ~scan be answered casil . If r r
-
(b') I nventory O,c e With a um orm, cons e
problem of op1imal inlerval between 1he s11ccess11 e Of' e Y cpresents Herc
the optimal interval between any two consecutive orders, "e have,
cD = Rs 20,000
r = Q*ID
A = Rs I SO/order
P is also called the invenlory cycle lime. . .
For our example, r = 500/2,000 = 0.25 year. And, since there arc 250 work mg days 111 the year, Ihis i = 24% = 0.24

equals 0.25 x 250 = 62.5 days.

It follows, therefore, that an order would be placed every 62.5 working days. implying flirt her that the
EOQ (in rupees) = J2 x 150 x 20,000
0.24
quantity ordered is sufficient to meet 62.5 days ' demand. = Rs 5.000
(c) Number qf Orders The optimal number of orders placed per year. N*. can also be obtained. It
equals the reciprocal of r.
Thus. N* = 1/T*. Thus, when r
= 0.25 = 1/4, N = -1 orders per year. Total cost, T(Q ) = Ji x 150 x 20,000 x 0.24
(d) Rupee Values The monetary value of the optimal order quantity and oft he av,TJgc inventory held = Rs 1,200
can also be determined, if needed. We have.
A closer look at the example would reveal that it is based on Example 9.1, and, therefore. has the same solution.
Rupee value of the EOQ = Q* x c (where c is the un it price)
= 500 X 10 = Rs 5.000
Robustness of the EOQ Model An important characteristic of the EOQ model is the robustness which
draws from the fact that the total cost curve is relatively flat at the bottom. TI1c model, therefore. tends to give
Qc reasonably good results even when parameter values are in error or they vary. We can investigate the sensitiv-
Rupee value of the average inventory = - -
2 ity of the model by considering changes in the ordering quantity and corresponding changes m the total cost.
500 This is useful in some cases a~ it gives the manager some flexibility in deciding on an order quant ity that might
= -2- x JO = Rs 2,500.
better meet the constraints. if any. For example, the EOQ might tum out to be 10.33 crates while the supplies
Many a time, the demand is expressed in monetary tenns rather than in units. In such cases, if the unit price is can be in IO or 11 crates. Herc the decision-maker would do well to determine the costs when IO or 11 crates
known. then the demand may be converted in units by dividing tl1e rupee demand by this unit cost price. are ordered and see which of the alternatives suits him better. Not only this, generally as the total cost curve is
Where, however, the unit cost is not given. this cannot be done and we can determine the economic order comparatively flat. as mentioned earlier, even significant departures from EOQ would not result in appreciable
quantity in rupee terms. When the demand is given in monetary terms, the holding cost must be expressed as a rise in the costs.
proportion (of the value of the inventory). Suppose we wish to determine the change in the cost associated with an order quantity which is k times the
Thus, if EOQ (thus if we wish to determine the effect of a 20"/o increase in the order size, Q = I.2Q0 ) .
cD = the annual demand in rupee terms, Since Q = kQ. we have

I I we have,
A = the acquisition cost,
i = the holding rate,
The cost associated with quantity Q would be
' T(Q) = ..@._+ kJiQ

I EOQ (in rupees) =

Total cost, T(Q*) = .J2AcDi

J2 AicD
The new cost (at Q) in relation to the cost at(!* is
kQ 2

Obviously, the total cost. T(Q) is the same as given in the earlier formulation. -AD
- +khQ
--
T(Q} _ .tQ 2
# l ju/,jrjQ Using the following data. obtain the EOQ and th8 tota1vanable
of ordering quantities of that size.
. .
cost associated with the po
!Icy
T((!*) - AD+~
Q* 2

Since AD - ~
Q" - 2 '
4
_S4'
___ Quantitative Techniques in Management

T(Q)
we have = hQ* hQ*
T({r) -+- ~

ltQ*+k ! hQ*
= 2khQ
I le
= -+ -
2lc 2

=(!+le )
For our TV picture tubes example. suppose we wish to detenni~e the effect of a 250' 0 increase in the Order
quantity on the cost. Here (r = 500 units. Q = 625 units (the desired level). and
le = 625 = 1.25
500
The cost ratio would be

T (Q) =
TQ
.!.. ( -1- +
2 1.25
1.2s) = ..!..2 (0.8 + t .2S) = 1.025
which implies that the cost would go up by 2.510 when the order quantity is increased by 25%. The cost would
similarly go up when we consider Q < Q-. From the fonnat of the relauonslup T (Q },T (Q-) it 1s clear that the
same result would be obtained when le. = 0.8 (M when le = 1.25) 1.e. when Q = 0 .8 x 500 = 400 units. So 1fthc
order quantity is decreased by 20% (from EOQ). then also the cost would go up by 2.510 (this may be vcnftc:d
from the infonnation given in Table 9 . 1) For the Example 9 . l. then. when the order quanuhes vary between
400 and 625 units, the total cost would increase by a margin of equal to or less than 2.51/o.
Review 'lf the Assumptions QfEOQ Model
1. In the EOQ model we assumt.-d that the demand for lhe item under consideration is certain. continuous
and constant. In reality, however. the demand is more hkely to be uncertain. discontinuous and van
able. We shall consider such situations later.
2 . Another assumption in the EOQ model is that all demlllld is supplied immediately and there is no
question of a shortage. However, even when the demand and lead time a.re known and constant
stockouts may be deliberately pennitted. Model 4 considc~ this situation.
When demand and lead time a.re not certain. the model needs modification and 5afety stocks arc
required to be kept. We shall discuss in detail the question of safety stocks later in the chapttr-
3. The EOQ model is based on the assumption that the unit price is the same. The analysis can be
extended to cover ituation.s when quantity discounts are a,ailable. The next model deals with dt1'
problem.
.i . Uniformity of the unit holding cost and of the cost of placing an order is the other undertying~
rion. If either or both of these assumptions are not satisfied. we can consider the EOQ model as
modified in (3) given earlier.
5. The implicit assumption in the EOQ model that the entire quantity ordered for w o u l d ~ ~ :
ingle lot. may n~ _hold true sorne~mes. If the supply of the goods is graduaJ ( pecially \\befl
source of supply I internal production). the model needs adjustment-sec Model 3.
 S00 Quantitative Techniques in Manageme 11t -------------------------~l~n!ve~n~t~oryz_M~a'.'.:n~a~g!em~e~nt~-.:5=:0~1
The economic order quantity for the planned sh
26 . I EOQ model with the same n t d onagcs model would be greater than that for the clas-
~ TEST YOUR UNDERSTANDING
s1ca 1 pu ata.
As the holding cost becomes large in relation h
27 ordered would be large. tot e back-ordering cost, the number of units back-

Ti ue) or F (False). 28 _ The four inventory models are deterministic in nature.

Mark the following statements as T ( r
. lacing an order and having the goods ready in stock ~o 29 Under the assumptions made in the inventory m0 d I h st
time and no safety stock is needed.
.
es, t e ock is always replenished at the designated
I. Lead time is the time elapsing between P . . ruse.
. . h t I demand during lead time is called safety stock.
2. The stock which 1s kept to meet t e to a . .
. d d pends on the variations m the demand rate and the lead t' 30. A I 00% customer service level requires
.
an amount of r k .
sa,ety sloe determmed as follows:
3. The amount of safety stock require e . 11ne. Safety Stock ~ maxnnum DDLT _ expected DDLT
4. Ordering cost is assumed to be independent of the 0rdcr quantity. . . .

I
1
3. Where demand
. . during lead
. time is assumed to be normally . d'1s1nbuted wit h a cenam
. mean and stan-
5. The ordering cost per unit is variable while the holding coSt per unit per tune period is fixed. dard dev1at10n. the service level corresponding to a given safety stock 1eve1sha11 be equa I to thc area
6. Stockout cost is the easiest to estimate. under the normaI curve tot hcleft of the re-order point.
7. In periodic review system of inventory management, the stock is usually replenished at equal tirne 32. Both mean
. and .standard deviation arc necessary to be known "or
,, determmmg
the service
1eve1corre-
intervals. sponding to a given amount.of safety stock, when the DDLTis given 10 be normally distributed.
8. The Wilson formulation assumes, among other things. that the demand for the item is fixed and con. 33. The system of periodic reviews generall y requires larger provisions for safety stock than does the
tinuous over time. fixed order quantity system.
9. When it is assumed that there are no variations in the demand rate and the lead time, the re-order level 34. The S_s system embodies the re-_ord_er feature of the fixed order quantity system and variable order
would be equal to the demand during lead time, and no safety stock is needed to be kept. quantity characteristic of the penod1c review system.
l 0. fllventory cycle is the time interval between the successive points of time when orders are placed. 35. The Ss system requires high safety stock volumes.
11. In the classical inventory model, the ordering and the holding costs are equal at EOQ. 36. In ABC analysis, the inventory items are classified into three categories on the basis of their usage
12. The relevant cost in the classical EOQ model is the sum of the ordering and holding costs. quantities.
13. With increases in the carrying cost, the optimal order quantity also increases. 37. The A-category items are those which fall in steep-rise segment of the curve of mal-distribution.
14. The total cost curve in the price break model is discontinuous. 38. The YEO analysis deals with classification of items on the basis of their availability.
15. In case of multiple price breaks, once a feasible EOQ is determined, the total cost function is evaluatedat 39. HML classifies items accordingly as they are high-usage, medium-usage or low-usage.
the EOQ so determined and each of the points at which the breaks are available. The point at whichthe 40. FNSD is the speed classification of items, accordingly as they are fast-moving, normal-moving, slow-
total cost is the minimum, gives the optimal order quantity. moving and dead items.

A
16. With same inputs of annual demand, ordering/set up cost, and holding cost, the economic lot size in
the build-up model is greater than economic order quantity in the classical EOQ model.
17. In the inventory model applicable to production runs, the production rate, p, must be greater than the EXERCISES
demand rate, d.
18. An increase in set-up cost per production run leads to a decrease in the economic lot size.
I. What are different types of inventories? Explain
19. For economic lot size, the total set-up cost need not be equal to the total holding cost.
2. What functions does inventory perform? State the two basic inventory decisions management must
20. It is permissible to incur both holding and shonage costs in the same inventory model.
make as they attempt to accomplish the functions of inventory j ust described by you.
2 1. The mventory model with planned shonages is applicable only when back-ordering is possible. (CA , May, 1995)
3. Distinguish between the fixed order quantity system and the periodic review system. Also explain the
22. If back-ordering is allowed the shona
model.

ge cost can be an 1mponant cost component m the mven
t ry
Ss system.
23. The total variable cost in the planned h . I ne 4. With-the help of quantity-cost curve. explain the significance of EOQ. What are the limitations of
I I h d d h Id' s onages model 1s split evenly between orderi ng cost on ue 0
an an o mg cost and shonage cost on the other.
24 . The economic order quantity increases with .
using the formula for an EOQ?
S. Discuss the assumptions widerlying the basic EOQ formula. Also, state the economic order quantity
.
. bl an mcrease m the back-ordering cost. model, discuss its sensitivity, and explain its major extensions. . . .
25. The tota I vana e cost for the planned sh n 1 ical 6- (a) Give the different motives to keep inventory in an organisation. Do you consider hoardmg as
EOQ model because of the inclusion of ano ages model would be greater than that for the c ass
additional component of shonage cost. inventory?
(b) Give the role of inflation and credit system in inventory management. (CA, May. /984)
 S02 Quan1i1ati1"1 Techniques i11 Management
. model kno
7. " lthough the clossic11l inventory dcc1son .
W . .
-----.._,
n as the: EOQ model. 1s too ovcrsin,pJ'fi
'n excellent starting point to develop more rear 1.0
11et1
rcprcscnt man) of the real-world s1tuo11ons, it '~1aht O!'this ,tatemcnL, cxphun the: maJor limitnt IS!ic
. .
and complex mventory dcc1,1on m es.
od I "In the 1g
.
.
developed by mnnagcmcnt ,c1cn11s1s to ovc 0
ons r
-----
l6. s ta

(")
11
--
te whether the follow111g statements arc correct c
(i) Safety stm:k mcrcascs as demand increases.
In ABC a11alv~1s high cost items arc
'. ,
1vc reasons:

l'k .
Inventory Management

.
most 1 e1Y to foll 1n category A and least cost items are
503

. 1 nJor techniques \ . rco likely to 111ll m Category C. ,

the EOQ modd. Also cxplalll tic m (. I ( 0 111, D<!/Ji;, 01c
2009 (iii) To protect aguin~t stockouts, u largc batch size is a must.
these. d ., cost nnd currying .:ost. Dn1\\ a rough sk J ) EOO is huscd on n balancing between in vcntory carrymg . costs and shortage costs.
. .1 h titutes the or cm1e . etch 10 (1v
8. (11) Explain, 111 dcta1. w at cons c, in opposite din.-cllon, with 111crcusc in lh J ad 11111e 1, the t11ne interval clap~ing bet I .
show the movement of these two coSI curv c Otdcr ( v ) ,c . . ween t 1c placement of a rcplcmshmcnt order and the
receipt of l:1't m,tulmcnt of goods against the order.
quantity. . h sketch ofa simple inventory mnd.:I ,hm, mg the rc-
17. . ss thc marginal annlysis to the dctem1inatio no r tI1c opumn
D1scu 1ordcnng site.
. In what cond111ons 1s
(b) Whut is n re-order point? Druw a roug . . I \f Com. Met Order
\ point ol'\lcr quantity and procurement 1tme. . . rut, 1983) it employed'?
I I . . ' . . . d ,h uwcntory management. Dcn\'c thc fmmulu for EOQ ()
9. D1,euss. 111 bncf, the costs u~soc1ate w1 , .
!8. Explain the. busics of ,ckct(i~e inventory control and state d11Tcrcnt selection techniques adopted in
Inventory Contro1Syslc.:m. nvc a bnefnotc on each. (ICJl'.4. December. /983)
2kb (a) '' ABl' analyst~ 1~ a very w,cful approach for selecti ve inventory control but has some major limita-
Q 19.
h(I - b/o) tions." Do you agree with this statement? Explain how thc~c limitations. if any, can be overcome.
(b) Explain the concept of the O-system, the P-system and the Two-Bin system for management of
"here, k ordering rost rcr set-up
inventories, by g1vmg appropriate examples. (MBA. Delhi, Noveml>er, /999)
i, holding cost of unit per time
20, Define selective mventory control. Explain the ABC. VED, IIML. SOE. S-0S. nnd FSN base~ of
t, ~ us:i11e rate per mut of time inventory classification. Arc they mutually exclusive?
" production rote per unit ofume (a~/,). (CA, Muy. /98JJ
1o. In n certain manufucturinl! situation, the production is instantanoous and the demand per dny is R.
how thnt till' optimal order quantity q per run which mmimises that total cost i,,
~ PRACTICAL PROBLEMS
2RC3(C1 + C1)
q
c1c2 l. A company has dctcnmned from 1ts analysis of production and accounting dnt11 that, for u part number
where, 1 1 is the c11st of holding one unit of mventory per day KC-438, the annual demand is equal to l 0,000 units, the co~t to purchase the item is Rs 36 per order,
C2 1s the umt cost of shortage per day and the holding cost 1s Rs 2/unil/ycar.
Detcnninc
C.\ is the set-up cost per nm. (~I Com. Bombay. /98}1 (a) What should the E:conomic Order Quantity be?
11 . What arc the rclc,ant coMs for inventory decisions'! llow are they obtained in real hfc situations? (b) What is the number of days supply per optimum order?
12. "An important chamtterist1c of the FOQ model is the robustnes~ which draws from the fact that the total 2. A factory follows an economtc order quantity system for maintaining stocks of one of iL~component
cost cune 1s rclnllvely Ont at the bottom." In light of this. mvcstigatc the sensitivity of the mood by requirements. The annual demand i~ for 24,000 units. the cost of placing an order is Rs 300. the
considering tht." cffc.'Cl of 11 ,o per cent change (on either side) in order quantity cm the iota) cost. component co~t is Rs 60 per umt. The factory has imputed 24% a, the inventory carrying rate
13 EOQ models. however complex. are restnclcd by so many assumptions that they have very limned (i) Find the optimal mten..al for placing ord=. assuming a year is equivalent to 360 days.
pract1cal value.' Do you a11rtt "1th this statement? Illustrate your an~wcr. (ii) If it is decidt.-d to place only one order per month, how much extra cosl would the factory incur per
1-4. (i) The 11nnual tkmamt for an item of in1cntory is D umt~. orderin1t cost~ arc H rupees per order, year us a consequence ofth1s decision? (DMS, Mumbai. 1998)
tmn.~portatmn costs per onlcr (il'TCSpQCl1vc of the number of unab transported) is T rupt,>es, annual 3. (a) For 1111 item, the annual demand is known to be 3.000 units which is unifonnly distributed over
mtcn:st charges arc t . oflhe value of m1ent0!)', imurance and warehousing charges amount to the ycur. The unit cost of the item is Rs 300 and the holding co~l is 10% of the value. It costs
Y of the 1aluc. nmt the pri,e of the: product 1s p rupees per unn. What w1II be the EOQ? Rs 450 to place an order for this product.
(ill Would the EOQ in _1hc case of 1,1.radual 1"1.X'etpl of goods ol'dcrcd he smaller or larger than tht Detcnninc
EOQ m the case of mstantaneous tttctpl all olhcr relevant data remaining thc same" Why? (i) the economic ordering quantity, EOQ.
( iii) L1,t the ntaJor "eaknc$.~cs of the class1cal EOQ modc I o f tnventory. (ii) the change in E:.OQ when the ordering cost changes Lo R.~600,
(1\) LISI lhree factors afTs'Cllng the ~-order l(\CI ofmventory.
(iii) the change 111 tOQ "hen the holding cost becomes 7.5% of the 11em value.
(1v) both, the ordering and the holding cosL~ change as in (1i) and (ii1), . .
15 'w'hat ~ safety -iock'? Why should it~ 1..ept by an orgamsauon'.'
(v) the per cent nsc m cost a.ssoc1at . ng 600 units rather than the EOQ obtained m
ed w1 th order
(1) above (using the cost figurc:1 given ongmally).
(.

504 Quantitative Techniques in Management Inventory Management

. ts If the demand for the next year incr
00
(b) ln a certain inventory system, the EOQ is _I,2 tourym ~ing costs increase (in addition toeasthcs b~ 8. Fill in the blanks:
? If the mven h ei
50%, what will be the new EOQ fth value of the inventory, w at will be the new" n- -,7.::7"~----------------
-;;::--:;;m;--:;Atnn~n;;;ua;i/~dkem~an;;;di-Oo;:;rdkeriri;ng;c;;o~s;-
t
. d d) from 25% to 40% o e cOQ? ' "' Unit holding cost lead time EOQ Re-order level
crease m the eman d and carrying cost per year as a percentag (units) {Rs) (Rs)
. g cost per or er, h e of th
(c) Theannualdeman. d buym d tsAandBaresame.However,t epriceofA iss . c
A 8.000 15
value of inventory in the case of two pro_ u;OO units what will be the EOQ for B? limes 0.06 10 days ? ?
as much as that of B. Jfthe EOQ for A is ' B ? 40 0.18 6days ? 2 16
C 7,500 ? 30.00
4. (a) Determine EOQ from the following data: ? 300 2 10
. t = Rs 200 per order
Ordenngcos For your calculations, assume . the number of working days m the year equal to 250.
= 20% of the unit cost per year
Carrying cost 9 The annual demand ofa particular item used by a company is . Th' .
10,000 umts. b b d
'd 1 . . 1s item may e o tame
Unit cost = Rs25 from either
an outs,
b I e supp 1er or subs1d1ary company The releva n a ,or t e procurement of the
t d ta r h
item are given e ow:
Annual requirement = Rs 50,000
Now if the annual requirement becomes as large as Rs 200,000 (i.e. 4 times the demand), Would Costs From outside supplier From subsidiary company
(b) ' . d ' ()?Wh?
the EOQ become four times as large as obtame m a Y Rs Rs
5. The following is the general information and infonnation pertaining to a product component n-1 Cost per unit 12 13
used by Kay Engineering Works: Cost of placing an order 10 JO
= Rs 60 per 100 Cost of receiving an order 20 15
Purchase price
Storage and all carrying cost, including capital
Annual usage = 1,20,000 units cost per unit per annum 2 2
Purchase office cost = Fixed Rs 16,320 per afl!lum, Variable Rs 12 per order
(i) What purchase quantity and from which source should you recommend to procure?
Rent and heating of component store = Rs 1,850 per annum (ii) What would be the minimum total cost in that case? (CA, May, 1992)
Interest = 20%; and Insurance = 0. 1% per annum based on total JO. The Heavy Nitro Company is considering the optimal batch size for re-order of concentrated sulphuric
purchases acid. The management has supplied the following information:
The purchase price of H2S04 is Rs 2 per gallon. The clerical and data processing costs are Rs I0.625
Deterioration =2% per afl!lum of all items purchased
per order. All the transport is done by rail. A charge of Rs 40 is made each time the special line to the
Required: factory is opened. A charge of20 paise per gallon is also made. The company use 40,000 gallons per
(a) calculate the EOQ for the component TT-4, annum. Maintenance costs of stock are Rs 4 per gallon per year. Each gallon requires 1/2 square foot
(b) calculate the percentage change in total armual variable costs (ofordering and holding) relating 10 of storage space. If warehouse space is not used, it can be rented out to Manganese Ltd. at Rs 2 per
the component TT-4 if the annual usage was (i) 25% more, and (ii) 25% less than the current square foot per annum. Available warehouse space is 1,000 square feet. the overhead costs being Rs
usage of 120,000 units. 2000 per annum.
Assume that all the free warehouse space can be rented out.
6. A company uses a certain component at the rate of8,000 units per year. Each component part is valued
(a) Calculate the economic re-order size.
at Rs 18. The company estimates that the cost of holding inventory is 20% of the value of the item,
(b) Calculate the minimum total annual cost of holding and re-ordering stock.
per year. The company has the option to produce the part on either of the two machines, A or B. (ICMA , May, /976, Adapted)
Macbme A bas a set-~p cost of Rs 200, machine B has a set-up cost of only Rs I00. However, it costs
1Opaise more per umt to produce using the machine B than it does using machine A. That is to say, the 11. (a) Finance managers regularly deal with the problem of determining the optimal level of cash to
cost of producmg the part on machine B would equal Rs 18. 1o per unit. keep in hand. Consider a company that has regular cash needs during a period. The problem for
the finance manager of this company is to determine the optimal amount of new funds to obtain
Which machine should the company use? What is the optimum lot size? from borrowing. The objective is to minimise the cost of going to the market for funds and the
7. The daily demand for a product is . . 00 d
th v .. . ap~roximate1YI00 umts. The ordering cost per order 1, Rs I 8~ opportunity cost associated with "carrying" the funds.
ea erage da,I_y holdmg cost per umt 1s 2 paise. If the lead time is 14 days determine the economic Let Q = amount of cash obtained from each bond issue (Rs per issue).
lot size for placing au order and also the re-order level. '
C0 = fixed cost associated with going to the market for funds by floating a bond issue (Rs per issue).
If the lead time is reduced to 7 day h -1 I el
h c h d . . s, w at wi I be the re-order level? How will tbe re-order ev Ch= annual opportunity (carrying) cost associated with having cash in hand.
c ange I t e Iea IJme increases to 21 days? //
(M Com, De 11, J985)
D = afl!lual cash needs (Rs per year),
506 Quantitative Techniques in Management
. ar that funds can be obtained in a det .
"fi
Assume that cash needs are uni orm
dunng the ye ' d r~ d
d are constant an una iecte by the si
eftntn18

. t rates on bon s ze of th
tic period of time, and that mter~s . d e
d 1.s not permitte . . .
bond issue. Shortage o f fun s al cost associated with borrowing and holct
. fi the total annu . lllg cash
(i) Write a general expression or C = S per annum, determme the optirnal .
00
(ii) If D = Rs I 00 million, Co= R~ 1OO,O e~ stould bond issues be floated? Size of
each bond issue. How many umes a y
For the data in (ii), determine: . bonds? The annual opportunity cost associated .
(iii) What is the annual cost of floating Wtth
holding cash? . sue be initiated if it takes five days to float an 1.
nd 1
(iv) At what level of cash shoul~ a bo (s_e days when the bond market and the firm a :,sue?
Assume 255 'trading' days ma year 1. c tVely
engage in their affairs).
. f h y market analysts concede that the percentage of the
(b) Because of the dynamics o t e mone ' go1 0 op.
. . d th holding cash may fluctuate between 1 0 and 121/o per annu
portumty cost associate w1 . . 1. . . m.
Conduct sensitivity analysis to determine the effects on your answers to parts (n), ( 11) and (iv)if
Ch assumes the extreme value of 12% per annum. (CA, November, 1992)
12. The Purchase Manager of Sigma Company is contacted by a new _supplier _who offers a quantity dis-
count on an item KR-100 being used by the company. The ordenng coS t is Rs 80 per order and the
holding cost 25 per cent of the average inventory value, on a yearly basis. The annual demand for this
item is 40 thousand units at a constant daily rate. The supplier states a price of Rs 80 per unit (which
is being currently paid by the company) and a discount of Rs 4 per unit if the company would order for
a least two thousand units of the item at a time. The manager is in a fix as to whether to take advantage
of this discount offer. What would you suggest him? Show a comparative analysis of the cost involved
in both the alternatives.
13. A purchase manager has decided to place an order for a minimum quantity of 500 units of a particular
item of inventory in order to get a discount of 10%. Past records reveal that last year 8 orders (each of
200 units) were placed. Given the ordering cost = Rs 500 per order, inventory carrying cost= 40%of
the inventory value, and price of the item= Rs 400 per unit, is the manager justified in his decision?
What is the effect of his decision to the company? (M Com, Delhi, J995)
14. Obtain the optimal order quantity using the information given here:
Annual requirement: 1 million units
Ordering and processing cost: Rs 28.80 per order
Holding cost: 20% of the unit cost
Price Schedule:
Order Size Unit Price
0-9,999 Rs 2.00
10,000-19,999
Rs 1.60
20,000 and above
Rs 1.40
15. The annual demand for an item of invento . 4
Rs 350 per order. Inventory holding ry is ~
st
oo units. The order processing costs amount 0t~
inventory. The normal price of the pr:~ st ~r~eShmated to be 2 per cent per month of the value .
discount of 7.5 per cent on an order of
more. Determine the EOQ.
~t
is s 1O per unit. However, the supplier offers a quanttt)'
a eaSt 4 OO units, and 12.5 per cent on an order of 600 units or
(M Com, Delhi, 200l)