12

Inventory Management

PowerPoint Slides
by Jeff Heyl

For Operations Management, 9e by

Krajewski/Ritzman/Malhotra
2010 Pearson Education

12 1

Inventory Management
Inventories are important to all types of
organizations

They have to be counted, paid for, used in

operations, used to satisfy customers, and
managed

Too much inventory reduces profitability

Too little inventory damages customer

confidence

Inventory trade-offs

12 2

ABC Analysis
Stock-keeping units (SKU)
Identify the classes so management can
control inventory levels
A Pareto chart
Cycle counting

12 3

ABC Analysis
100
90

Percentage of dollar value

Class C

Class B

80 Class A
70
60
50
40
30
20
10
0
10

20

30

40

50

60

70

80

90 100

Percentage of SKUs
Figure 12.1 Typical Chart Using ABC Analysis
12 4

Economic Order Quantity

The lot size, Q, that minimizes total annual
inventory holding and ordering costs
Five assumptions
1. Demand rate is constant and known with certainty
2. No constraints are placed on the size of each lot
3. The only two relevant costs are the inventory holding
cost and the fixed cost per lot for ordering or setup
4. Decisions for one item can be made independently of
decisions for other items
5. The lead time is constant and known with certainty

12 5

Economic Order Quantity

Dont use the EOQ

Make-to-order strategy

Order size is constrained

Modify the EOQ

Quantity discounts

Replenishment not instantaneous

Use the EOQ

Make-to-stock

Carrying and setup costs are known and

relatively stable
12 6

Calculating EOQ

On-hand inventory (units)

Receive
order

Inventory depletion
(demand rate)

Average
cycle
inventory

Q
2

1 cycle

Time

Figure 12.2 Cycle-Inventory Levels

12 7

Calculating EOQ
Annual holding cost
Annual holding cost = (Average cycle inventory)
(Unit holding cost)

Annual ordering cost

Annual ordering cost = (Number of orders/Year)
(Ordering or setup costs)

Total annual cycle-inventory cost

Total costs = Annual holding cost
+ Annual ordering or setup cost

12 8

Annual cost (dollars)

Calculating EOQ

Total cost

Holding cost

Ordering cost

Lot Size (Q)

Figure 12.3 Graphs of Annual Holding, Ordering, and Total Costs
12 9

Calculating EOQ
Total annual cycle-inventory cost
Q
D
C = 2 (H) +
(S)
Q
where
C = total annual cycle-inventory cost
Q = lot size
H = holding cost per unit per year
D = annual demand
S = ordering or setup costs per lot

12 10

The Cost of a Lot-Sizing Policy

EXAMPLE 12.1
A museum of natural history opened a gift shop which
operates 52 weeks per year.
Managing inventories has become a problem.
Top-selling SKU is a bird feeder.
Sales are 18 units per week, the supplier charges $60 per
unit.
Ordering cost is $45.
Annual holding cost is 25 percent of a feeders value.
Management chose a 390-unit lot size.
What is the annual cycle-inventory cost of the current policy
of using a 390-unit lot size?
Would a lot size of 468 be better?
12 11

The Cost of a Lot-Sizing Policy

SOLUTION
We begin by computing the annual demand and holding cost as
D = (18 units/week)(52 weeks/year) = 936 units
H = 0.25($60/unit) = $15
The total annual cycle-inventory cost for the current policy is
Q
390
936
D
C = 2 (H) + Q (S) =
2 ($15) + 390 ($45)
= $2,925 + $108 = $3,033
The total annual cycle-inventory cost for the alternative lot
size is
468
936
C=
2 ($15) + 468 ($45) = $3,510 + $90 = $3,600

12 12

The Cost of a Lot-Sizing Policy

Figure 12.4 Total Annual Cycle-Inventory Cost
Function for the Bird Feeder

Current
cost

Annual cost (dollars)

3000

Q
D
Total
= 2 (H) +
(S)
cost
Q

2000

Q
Holding cost = 2 (H)

1000
Ordering cost =

Lowest
cost
0

50

100

Best Q
(EOQ)

150 200

250 300 350

Lot Size (Q)

D
(S)
Q

400

Current
Q
12 13

Calculating EOQ
The EOQ formula:
EOQ =

2DS
H

Time between orders

TBOEOQ =

EOQ
(12 months/year)
D

12 14

Finding the EOQ, Total Cost, TBO

EXAMPLE 12.2
For the bird feeders in Example 12.1, calculate the EOQ and its
total annual cycle-inventory cost. How frequently will orders be
placed if the EOQ is used?
SOLUTION
Using the formulas for EOQ and annual cost, we
get
EOQ =

2DS
H

2(936)(45)
15

= 74.94 or 75 units

12 15

Finding the EOQ, Total Cost, TBO

Figure 12.5 shows that the total annual cost is much less than
the $3,033 cost of the current policy of placing 390-unit orders.

Figure 12.5 Total Annual Cycle-Inventory Costs Based

on EOQ Using Tutor 12.2
12 16

Finding the EOQ, Total Cost, TBO

When the EOQ is used, the TBO can be expressed in various
ways for the same time period.
EOQ
75
TBOEOQ =
=
= 0.080 year
D
936
EOQ
75
TBOEOQ =
(12
months/year)
=
(12) = 0.96 month
D
936
EOQ
75
TBOEOQ =
D (52 weeks/year) = 936 (52) = 4.17 weeks
EOQ
75
TBOEOQ =
(365
days/year)
=
(365) = 29.25 days
D
936

12 17

Application 12.1
Suppose that you are reviewing the inventory policies on an
$80 item stocked at a hardware store. The current policy is to
replenish inventory by ordering in lots of 360 units. Additional
information is:
D = 60 units per week, or 3,120 units per year
S = $30 per order
H = 25% of selling price, or $20 per unit per year
What is the EOQ?
SOLUTION
EOQ =

2DS
H

2(3,120)(30)
= 97 units
20

12 18

Application 12.1
What is the total annual cost of the current policy (Q = 360), and
how does it compare with the cost with using the EOQ?
Current Policy

EOQ Policy

Q = 360 units

Q = 97 units

C = (360/2)(20) + (3,120/360)(30)

C = (97/2)(20) + (3,120/97)(30)

C = 3,600 + 260

C = 970 + 965

C = $3,860

C = $1,935

12 19

Application 12.1
What is the time between orders (TBO) for the current policy
and the EOQ policy, expressed in weeks?
SOLUTION
360
(52 weeks per year) = 6 weeks
TBO360 =
3,120

TBOEOQ =

97
(52 weeks per year) = 1.6 weeks
3,120

12 20

Managerial Insights
TABLE 12.1
Parameter

SENSITIVITY ANALYSIS OF THE EOQ

EOQ

Parameter
Change

EOQ
Change

Comments

Increase in lot size is in proportion to the

square root of D.

Demand

2DS
H

Order/Setup
Costs

2DS
H

Weeks of supply decreases and inventory

turnover increases because the lot size
decreases.

Holding
Costs

2DS
H

Larger lots are justified when holding

costs decrease.

12 21

Inventory Control Systems

Two important questions:

How much?

When?

Nature of demand

Independent demand

Dependent demand

12 22

Inventory Control Systems

Continuous review (Q) system
Reorder

point system (ROP) and fixed order

quantity system

For

independent demand items

Tracks

inventory position (IP)

Includes

scheduled receipts (SR), on-hand

inventory (OH), and back orders (BO)

Inventory position = On-hand inventory + Scheduled receipts

Backorders
IP = OH + SR BO

12 23

Selecting the Reorder Point

IP

On-hand inventory

Order
received

IP

Order
received

Order
received

Q
OH

OH

IP

Order
received

Q
OH

R
Order
placed

Order
placed
L

TBO

Order
placed
L

TBO

Time

TBO

Figure 12.6 Q System When Demand and Lead Time Are Constant and Certain

12 24

Application 12.2
The on-hand inventory is only 10 units, and the reorder point
R is 100. There are no backorders and one open order for
200 units. Should a new order be placed?
SOLUTION
IP = OH + SR BO = 10 + 200 0 = 210
R = 100

Decision: Place no new order

12 25

Placing a New Order

EXAMPLE 12.3
Demand for chicken soup at a supermarket is always 25 cases
a day and the lead time is always 4 days. The shelves were just
restocked with chicken soup, leaving an on-hand inventory of
only 10 cases. No backorders currently exist, but there is one
open order in the pipeline for 200 cases. What is the inventory
position? Should a new order be placed?
SOLUTION
R=
Total demand during lead
time == 100 cases
(25)(4)
IP = OH + SR BO
= 10 + 200 0 = 210 cases

12 26

Continuous Review Systems

Selecting the reorder point with variable demand
and constant lead time
Reorder point

= Average demand during lead time

+ Safety stock
= dL + safety stock

where
d = average demand per week (or day or months)
L = constant lead time in weeks (or days or months)

12 27

Continuous Review Systems

IP
Order
received

On-hand inventory

Order
received

IP

IP

Order
received

Order
received
Q

R
Order
placed

Order
placed

Order
placed

0
L1
TBO1

L2
TBO2

L3

Time

TBO3

Figure 12.7 Q System When Demand Is Uncertain

12 28

Reorder Point
1. Choose an appropriate service-level policy

Select service level or cycle service level

Protection interval

2. Determine the demand during lead time

probability distribution
3. Determine the safety stock and reorder
point levels

12 29

Demand During Lead Time

Specify mean and standard deviation
Standard deviation of demand during lead time
dLT =

d2L = d

Safety stock and reorder point

Safety stock = zdLT
where
z=
number of standard deviations needed to
achieve the cycle-service level
dLT = stand deviation of demand during lead time

Reorder point = R = dL + safety stock

12 30

Demand During Lead Time

t = 15

t = 15

+
75
Demand for week 1

+
75
Demand for week 2

t = 15

=
75
Demand for week 3

t = 25.98

225
Demand for 3-week lead time

Figure 12.8 Development of Demand

Distribution for the Lead
Time

12 31

Demand During Lead Time

Cycle-service level = 85%

Probability of stockout
(1.0 0.85 = 0.15)
Average
demand
during
lead time

R
zdLT

Figure 12.9 Finding Safety Stock with a Normal Probability Distribution for an
85 Percent Cycle-Service Level

12 32

Reorder Point for Variable Demand

EXAMPLE 12.4
Let us return to the bird feeder in Example 12.2. The EOQ is
75 units. Suppose that the average demand is 18 units per
week with a standard deviation of 5 units. The lead time is
constant at two weeks. Determine the safety stock and
reorder point if management wants a 90 percent cycleservice level.

12 33

Reorder Point for Variable Demand

SOLUTION
In this case, d = 5, d = 18 units, and L = 2 weeks, so
dLT = d L = 5 2 = 7.07. Consult the body of the table in the
Normal Distribution appendix for 0.9000, which corresponds to
a 90 percent cycle-service level. The closest number is 0.8997,
which corresponds to 1.2 in the row heading and 0.08 in the
column heading. Adding these values gives a z value of 1.28.
With this information, we calculate the safety stock and reorder
point as follows:
Safety stock = zdLT = 1.28(7.07) = 9.05 or 9 units
Reorder point = dL + Safety stock = 2(18) + 9 = 45 units

12 34

Application 12.3
Suppose that the demand during lead time is normally
distributed with an average of 85 and dLT = 40. Find the safety
stock, and reorder point R, for a 95 percent cycle-service level.
SOLUTION
Safety stock = zdLT = 1.645(40) = 65.8 or 66 units
R = Average demand during lead time + Safety stock
R = 85 + 66 = 151 units
Find the safety stock, and reorder point R, for an 85 percent
cycle-service level.
Safety stock = zdLT = 1.04(40) = 41.6 or 42 units
R = Average demand during lead time + Safety stock
R = 85 + 42 = 127 units
12 35

Reorder Point for Variable Demand

and Lead Time
Often the case that both are variable
The equations are more complicated
Safety stock = zdLT
R=
(Average weekly demand Average lead time)
+ Safety stock
= dL + Safety stock
where

d = Average weekly (or daily or monthly) demand

L = Average lead time
d = Standard deviation of weekly (or daily or monthly) demand
LT = Standard deviation of the lead time
dLT =
Ld2 + d2LT2
12 36

Reorder Point
EXAMPLE 12.5
The Office Supply Shop estimates that the average demand for
a popular ball-point pen is 12,000 pens per week with a
standard deviation of 3,000 pens. The current inventory policy
calls for replenishment orders of 156,000 pens. The average
lead time from the distributor is 5 weeks, with a standard
deviation of 2 weeks. If management wants a 95 percent cycleservice level, what should the reorder point be?

12 37

Reorder Point
SOLUTION
We have d = 12,000 pens, d = 3,000 pens, L = 5 weeks,
and LT = 2 weeks
dLT = Ld2 + d2LT2 =

(5)(3,000)2 + (12,000)2(2)2
= 24,919.87 pens

From the Normal Distribution appendix for 0.9500, the

appropriate z value = 1.65. We calculate the safety stock and
reorder point as follows:
Safety stock = zdLT = (1.65)(24,919.87)
= 41,117.79 or 41,118 pens
Reorder point = dL + Safety stock = (12,000)(5) + 41.118
= 101,118 pens
12 38

Application 12.4
Grey Wolf lodge is a popular 500-room hotel in the North
Woods. Managers need to keep close tabs on all of the room
service items, including a special pint-scented bar soap. The
daily demand for the soap is 275 bars, with a standard
deviation of 30 bars. Ordering cost is $10 and the inventory
holding cost is $0.30/bar/year. The lead time from the supplier
is 5 days, with a standard deviation of 1 day. The lodge is open
365 days a year.
What should the reorder point be for the bar of soap if
management wants to have a 99 percent cycle-service?

12 39

Application 12.4
SOLUTION

d = 275 bars
L = 5 days
d = 30 bars
LT =1 day
dLT =

Ld2283.06
+ d2LT2bars
=

From the Normal Distribution appendix for 0.9900, z = 2.33.

We calculate the safety stock and reorder point as follows;
Safety stock = zdLT = (2.33)(283.06) = 659.53 or 660 bars
Reorder point + safety stock = dL + safety stock
= (275)(5) + 660 = 2,035 bars
12 40

Continuous Review Systems

Two-Bin system

Visual system

An empty first bin signals the need to place an order

Calculating total systems costs

Total cost = Annual cycle inventory holding cost
+ Annual ordering cost
+ Annual safety stock holding cost
Q
D
C = 2 (H) +
(S) + (H) (Safety stock)
Q

12 41

Application 12.5
The Discount Appliance Store uses a continuous review system
(Q system). One of the companys items has the following
characteristics:
Demand = 10 units/wk (assume 52 weeks per year)
Ordering and setup cost (S) = $45/order
Holding cost (H) = $12/unit/year
Lead time (L) = 3 weeks (constant)
Standard deviation in weekly demand = 8 units
Cycle-service level = 70%

12 42

Application 12.5
SOLUTION
What is the EOQ for this item?
D = 10/wk 52 wks/yr = 520 units
EOQ =

2DS
H

2(520)(45)
= 62 units
12

What is the desired safety stock?

dLT = d L = 8 3 = 14 units
Safety stock = zdLT = 0.525(14) = 8 units

12 43

Application 12.5
What is the desired reorder point R?
R = Average demand during lead time + Safety stock
R = 3(10) + 8 = 38 units
What is the total annual cost?
62
520
C = 2 ($12) + 62 ($45) + 8($12) = $845.42

12 44

Application 12.5
Suppose that the current policy is Q = 80 and R = 150. What will
be the changes in average cycle inventory and safety stock if
your EOQ and R values are implemented?
Reducing Q from 80 to 62
Cycle inventory reduction = 40 31 = 9 units
Safety stock reduction = 120 8 = 112 units
Reducing R from 150 to 38

12 45

Periodic Review System (P)

Fixed interval reorder system or periodic reorder
system
Four of the original EOQ assumptions maintained

No constraints are placed on lot size

Holding and ordering costs

Independent demand

Lead times are certain

Order is placed to bring the inventory position up

to the target inventory level, T, when the
predetermined time, P, has elapsed

12 46

Periodic Review System (P)

On-hand inventory

IP
Q1

IP

Order
received
OH

Order
received

Q2

IP
Q3

Order
received

OH

IP1
IP3

Order
placed

Order
placed

IP2

L
P

Time

Protection interval
Figure 12.10 P System When Demand Is Uncertain
12 47

How Much to Order in a P System

EXAMPLE 12.6
A distribution center has a backorder for five 36-inch color TV
sets. No inventory is currently on hand, and now is the time to
review. How many should be reordered if T = 400 and no
receipts are scheduled?
SOLUTION

IP = OH + SR BO
= 0 + 0 5 = 5 sets
T IP = 400 (5) = 405 sets

That is, 405 sets must be ordered to bring the inventory

position up to T sets.

12 48

Application 12.6
The on-hand inventory is 10 units, and T is 400. There are no
back orders, but one scheduled receipt of 200 units. Now is the
time to review. How much should be reordered?
SOLUTION
IP = OH + SR BO
= 10 + 200 0 = 210
T IP = 400 210 = 190
The decision is to order 190 units

12 49

Periodic Review System

Selecting the time between reviews,
choosing P and T
Selecting T when demand is variable and
lead time is constant

IP covers demand over a protection interval of

P+L

The average demand during the protection

interval is d(P + L), or

T = d(P + L) + safety stock for protection interval

Safety stock = zP + L , where P + L = d P L
12 50

Calculating P and T
EXAMPLE 12.7
Again, let us return to the bird feeder example. Recall that
demand for the bird feeder is normally distributed with a mean of
18 units per week and a standard deviation in weekly demand of
5 units. The lead time is 2 weeks, and the business operates 52
weeks per year. The Q system developed in Example 12.4 called
for an EOQ of 75 units and a safety stock of 9 units for a cycleservice level of 90 percent. What is the equivalent P system?
Answers are to be rounded to the nearest integer.

12 51

Calculating P and T
SOLUTION
We first define D and then P. Here, P is the time between
reviews, expressed in weeks because the data are expressed
as demand per week:
D = (18 units/week)(52 weeks/year) = 936 units
EOQ
75
(52) = 4.2 or 4 weeks
P=
(52) =
D
936
With d = 18 units per week, an alternative approach is to
calculate P by dividing the EOQ by d to get 75/18 = 4.2 or 4
weeks. Either way, we would review the bird feeder inventory
every 4 weeks.

12 52

Calculating P and T
We now find the standard deviation of demand over the
protection interval (P + L) = 6:

P L d P L 5 6 12.25units
Before calculating T, we also need a z value. For a 90 percent
cycle-service level z = 1.28. The safety stock becomes
Safety stock = zP + L = 1.28(12.25) = 15.68 or 16 units
We now solve for T:
T = Average demand during the protection interval + Safety stock
= d(P + L) + safety stock
= (18 units/week)(6 weeks) + 16 units = 124 units
12 53

Periodic Review System

Use simulation when both demand and lead time
are variable
Suitable to single-bin systems
Total costs for the P system are the sum of the
same three cost elements as in the Q system
Order quantity and safety stock are calculated
differently
dP
D
C = 2 (H) + dP (S) + HzP + L

12 54

Application 12.7
Return to Discount Appliance Store (Application 12.4), but now
use the P system for the item.
Previous information
Demand = 10 units/wk (assume 52 weeks per year) = 520
EOQ = 62 units (with reorder point system)
Lead time (L) = 3 weeks
Standard deviation in weekly demand = 8 units
z = 0.525 (for cycle-service level of 70%)

Reorder interval P, if you make the average lot size using the
Periodic Review System approximate the EOQ.

12 55

Application 12.7
SOLUTION
Reorder interval P, if you make the average lot size using the
Periodic Review System approximate the EOQ.
P = (EOQ/D)(52) = (62/529)(52) = 6.2 or 6 weeks
Safety stock
Safety stock = d P L
8 6 3 12.6 or 13units
0.525
Target inventory
T = d(P + L) + safety stock for protection interval
T = 10(6 + 3) + 13 = 103 units

12 56

Application 12.7
Total cost
dP
D
C = 2 (H) + dP (S) + HzP + L
10(6)
520
=
2 ($12) + 10(6) ($45) + (13)($12) = $906.00

12 57

Comparative Advantages
Primary advantages of P systems
Convenient
Orders
Only

can be combined

need to know IP when review is made

Primary advantages of Q systems

Review
Fixed

frequency may be individualized

lot sizes can result in quantity discounts

Lower

safety stocks

12 58

Hybrid systems
Optional replenishment systems

Optimal review, min-max, or (s,S) system, like the P

system

Reviews IP at fixed time intervals and places a variablesized order to cover expected needs

Ensures that a reasonable large order is placed

Base-stock system

Replenishment order is issued each time a withdrawal

is made

Order quantities vary to keep the inventory position at R

Minimizes cycle inventory, but increases ordering costs

Appropriate for expensive items

12 59

Solved Problem 1
Bookers Book Bindery divides SKUs into three classes,
according to their dollar usage. Calculate the usage values of
the following SKUs and determine which is most likely to be
classified as class A.
SKU Number

Description

Boxes

Quantity Used
per Year

Unit Value
($)

500

3.00

Cardboard
(square feet)

18,000

0.02

Cover stock

10,000

0.75

Glue (gallons)

75

40.00

Inside covers

20,000

0.05

Reinforcing tape
(meters)

3,000

0.15

Signatures

150,000

0.45

12 60

Solved Problem 1
SOLUTION
The annual dollar usage for each item is determined by
multiplying the annual usage quantity by the value per unit. As
shown in Figure 12.11, the SKUs are then sorted by annual
dollar usage, in declining order. Finally, AB and BC class
lines are drawn roughly, according to the guidelines presented
in the text. Here, class A includes only one SKU (signatures),
which represents only 1/7, or 14 percent, of the SKUs but
accounts for 83 percent of annual dollar usage. Class B
includes the next two SKUs, which taken together represent 28
percent of the SKUs and account for 13 percent of annual dollar
usage. The final four SKUs, class C, represent over half the
number of SKUs but only 4 percent of total annual dollar usage.

12 61

Solved Problem 1
SKU
Number

Description

Boxes

Quantity
Used per
Year

Unit Value
($)

Annual Dollar
Usage ($)

500

3.00

1,500

Cardboard
(square feet)

18,000

0.02

360

Cover stock

10,000

0.75

7,500

Glue (gallons)

75

40.00

3,000

Inside covers

20,000

0.05

1,000

Reinforcing tape
(meters)

3,000

0.15

450

Signatures

150,000

0.45

67,500

Total

81,310

12 62

Solved Problem 1

Percentage of Dollar Value

100

Class B

Class C

90 Class
80

70
60
50
40

Figure 12.11 Annual Dollar Usage for

Class A, B, and C SKUs
Using Tutor 12.2

30
20
10
0
10

20 30 40 50 60 70 80 90 100
Percentage of SKUs
12 63

Solved Problem 2
Nelsons Hardware Store stocks a 19.2 volt cordless drill that is
a popular seller. Annual demand is 5,000 units, the ordering
cost is $15, and the inventory holding cost is $4/unit/year.
a. What is the economic order quantity?
b. What is the total annual cost for this inventory item?
SOLUTION
a. The order quantity is
EOQ =

2DS
H

2(5,000)($15)
$4

37,500 = 193.65 or 194 drills

b. The total annual cost is

Q
194
5,000
D
($4) +
($15) = $774.60
C = 2 (H) +
(S) =
Q
2
194
12 64

Solved Problem 3
A regional distributor purchases discontinued appliances from
various suppliers and then sells them on demand to retailers in
the region. The distributor operates 5 days per week, 52 weeks
per year. Only when it is open for business can orders be
received. Management wants to reevaluate its current inventory
policy, which calls for order quantities of 440 counter-top
mixers. The following data are estimated for the mixer:
Average daily demand (d) = 100 mixers
Standard deviation of daily demand (d) = 30 mixers
Lead time (L) = 3 days
Holding cost (H) = $9.40/unit/year
Ordering cost (S) = $35/order
Cycle-service level = 92 percent
The distributor uses a continuous review (Q) system
12 65

Solved Problem 3
a. What order quantity Q, and reorder point, R, should be used?
b. What is the total annual cost of the system?
c. If on-hand inventory is 40 units, one open order for 440
mixers is pending, and no backorders exist, should a new
order be placed?

12 66

Solved Problem 3
SOLUTION
a. Annual demand is
D = (5 days/week)(52 weeks/year)(100 mixers/day)
= 26,000 mixers/year
The order quantity is
EOQ =

2DS
=
H
=

2(26,000)($35)
$9.40
193,167 = 440.02 or 440 mixers

12 67

Solved Problem 3
The standard deviation of the demand during lead time
distribution is
dLT = d L = 30 3 = 51.96
A 92 percent cycle-service level corresponds to z = 1.41
Safety stock = zdLT = 1.41(51.96 mixers) = 73.26 or 73 mixers
Average demand during lead time = dL = 100(3) = 300 mixers
Reorder point (R) = Average demand during lead time + Safety stock
= 300 mixers + 73 mixers = 373 mixers
With a continuous review system, Q = 440 and R = 373
12 68

Solved Problem 3
b. The total annual cost for the Q systems is
Q
D
C = 2 (H) + Q (S) + (H)(Safety stock)
26,000
440
C=
($9.40) +
($35) + ($9.40)(73) = $4,822.38
440
2
c.

Inventory position = On-hand inventory

+ Scheduled receipts Backorders
IP = OH + SR BO = 40 + 440 0 = 480 mixers
Because IP (480) exceeds R (373), do not place a new order

12 69

Solved Problem 4
Suppose that a periodic review (P) system is used at the
distributor in Solved Problem 3, but otherwise the data are the
same.
a. Calculate the P (in workdays, rounded to the nearest day)
that gives approximately the same number of orders per
year as the EOQ.
b. What is the target inventory level, T? Compare the P system
to the Q system in Solved Problem 3.
c. What is the total annual cost of the P system?
d. It is time to review the item. On-hand inventory is 40 mixers;
receipt of 440 mixers is scheduled, and no backorders exist.
How much should be reordered?

12 70

Solved Problem 4
SOLUTION
a. The time between orders is
EOQ
440
(260) = 4.4 or 4 days
P=
(260 days/year) =
D
26,000
b. Figure 12.12 shows that T = 812 and safety stock
= (1.41)(79.37) = 111.91 or about 112 mixers. The
corresponding Q system for the counter-top mixer requires
less safety stock.

Figure 12.12
OM Explorer Solver
for Inventory
Systems

12 71

Solved Problem 4
c. The total annual cost of the P system is
dP
D
C = 2 (H) + dP (S) + (H)(Safety stock)
100(4)
26,000
C=
2 ($9.40) + 100(4) ($35) + ($9.40)(1.41)(79.37)
= $5,207.80
d. Inventory position is the amount on hand plus scheduled
receipts minus backorders, or
IP = OH + SR BO = 40 + 440 0 = 480 mixers
The order quantity is the target inventory level minus the
inventory position, or
Q = T IP = 812 mixers 480 mixers = 332 mixers
An order for 332 mixers should be placed.
12 72

Solved Problem 5
Grey Wolf Lodge is a popular 500-room hotel in the North
Woods. Managers need to keep close tabs on all room service
items, including a special pine-scented bar soap. The daily
demand for the soap is 275 bars, with a standard deviation of
30 bars. Ordering cost is $10 and the inventory holding cost is
$0.30/bar/year. The lead time from the supplier is 5 days, with a
standard deviation of 1 day. The lodge is open 365 days a year.
a. What is the economic order quantity for the bar of soap?
b. What should the reorder point be for the bar of soap if
management wants to have a 99 percent cycle-service level?
c. What is the total annual cost for the bar of soap, assuming a
Q system will be used?

12 73

Solved Problem 5
SOLUTION
a. We have D = (275)(365) = 100,375 bars of soap; S = $10; and
H = $0.30. The EOQ for the bar of soap is

EOQ =

2DS
=
H
=

2(100,375)($10)
$0.30
6,691,666.7 = 2,586.83 or 2,587 bars

12 74

Solved Problem 5
b. We have d = 275 bars/day, d = 30 bars, L = 5 days,
and LT = 1 day.
dLT =

Ld2 +(5)(30)
d2LT2 2 =+ (275)2(1)2 = 283.06 bars

Consult the body of the Normal Distribution appendix for

0.9900. The closest value is 0.9901, which corresponds to
a z value of 2.33. We calculate the safety stock and reorder
point as follows:
Safety stock = zdLT = (2.33)(283.06) = 659.53 or 660 bars
Reorder point = dL + Safety stock = (275)(5) + 660 = 2,035 bars

12 75

Solved Problem 5
c. The total annual cost for the Q system is
Q
D
C = 2 (H) + Q (S) + (H)(Safety stock)
2,587
100,375
C=
2 ($0.30) + 2,587 ($10) + ($0.30)(660) = $974.05

12 76

Solved Problem 6
Zekes Hardware Store sells furnace filters. The cost to place an
order to the distributor is $25 and the annual cost to hold a
filter in stock is $2. The average demand per week for the filters
is 32 units, and the store operates 50 weeks per year. The
weekly demand for filters has the probability distribution
shown on the left below.
The delivery lead time from the distributor is uncertain and has
the probability distribution shown on the right below.
Suppose Zeke wants to use a P system with P = 6 weeks and a
cycle-service level of 90 percent. What is the appropriate value
for T and the associated annual cost of the system?

12 77

Solved Problem 6

Demand

Probability

Lead Time (wks)

Probability

24

0.15

0.05

28

0.20

0.25

32

0.30

0.40

36

0.20

0.25

40

0.15

0.05

12 78

Solved Problem 6
SOLUTION
Figure 12.13 contains output from the Demand During the
Protection Interval Simulator from OM Explorer.

Figure 12.13 OM Explorer Solver for Demand during the Protection

Interval
12 79

Solved Problem 6
Given the desired cycle-service level of 90 percent, the
appropriate T value is 322 units. The simulation estimated the
average demand during the protection interval to be 289 units,
consequently the safety stock is 322 289 = 33 units.
The annual cost of this P system is
6(32)
50(32)
C=
2 ($2) + 6(32) ($25) + (33)($2)
= $192.00 + $208.33 + $66.00 = $466.33

12 80

Solved Problem 7
Consider Zekes inventory in Solved Problem 6. Suppose that
he wants to use a continuous review (Q) system for the filters,
with an order quantity of 200 and a reorder point of 140. Initial
inventory is 170 units. If the stockout cost is $5 per unit, and all
of the other data in Solved Problem 6 are the same, what is the
expected cost per week of using the Q system?
SOLUTION
Figure 12.14 shows output from the Q System Simulator in OM
Explorer. Only weeks 1 through 13 and weeks 41 through 50
are shown in the figure. The average total cost per week is
$305.62. Notice that no stockouts occurred in this simulation.
These results are dependent on Zekes choices for the reorder
point and lot size. It is possible that stockouts would occur if
the simulation were run for more than 50 weeks.

12 81

Solved Problem 7

Figure 12.14 OM Explorer Q System Simulator

12 82

12 83