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Attribution Non-Commercial (BY-NC)

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Chapter 3

Continuous Probability Distributions

Case Problem: Specialty Toys

1.

.

025

.

95

10,000

20,000

At x = 30,000,

z=

=

= 1.96

= 5102

1.96

2.

= 5102

@ 15,000

z=

= 0.98

5102

@ 18,000

z=

= 0.39

5102

@ 24,000

CP - 18

.

025

30,000

Chapter 3

z=

= 0.78

5102

@ 28,000

z=

= 1.57

5102

3.

Profit projections for the order quantities under the 3 scenarios are computed below:

Order Quantity: 15,000

Sales

Unit Sales

10,000

20,000

30,000

Total Cost

240,000

240,000

240,000

at $24

240,000

360,000

360,000

at $5

25,000

0

0

Profit

25,000

120,000

120,000

Sales

Unit Sales

10,000

20,000

30,000

Total Cost

288,000

288,000

288,000

at $24

240,000

432,000

432,000

at $5

40,000

0

0

Profit

-8,000

144,000

144,000

Sales

Unit Sales

10,000

20,000

30,000

Total Cost

384,000

384,000

384,000

at $24

240,000

480,000

576,000

at $5

70,000

20,000

0

Profit

-74,000

116,000

192,000

Sales

Unit Sales

10,000

Total Cost

448,000

at $24

240,000

at $5

90,000

CP - 19

Profit

-118,000

Chapter 3

20,000

30,000

4.

448,000

448,000

480,000

672,000

40,000

0

72,000

224,000

We need to find an order quantity that cuts off an area of .70 in the lower tail of the normal curve for

demand.

30%

70%

20,000 Q

z = 0.52

Q 20, 000

z=

= 0.52

5102

Q = 20,000 + 0.52(5102) = 22,653

Order Quantity: 22,653

Sales

Unit Sales

10,000

20,000

30,000

Total Cost

362,488

362,488

362,488

at $24

240,000

480,000

543,672

at $5

63,265

13,265

0

CP - 20

Profit

-59,183

130,817

181,224

Chapter 3

5.

A variety of recommendations are possible. The students should justify their recommendation by

showing the projected profit obtained under the 3 scenarios used in parts 3 and 4. An order quantity

in the 18,000 to 20,000 range strikes a good compromise between the risk of a loss and generating

good profits.

While the students don't have the benefit of the following, a single-period inventory model

(sometimes called the news vendor model) shows how to find an optimal solution. We outline that

solution below.

A single-period inventory model recommends an order quantity that maximizes expected profit

based on the following formula:

P(Demand Q* ) =

cu

cu + co

*

where P(Demand Q ) is the probability that demand is less than or equal to the recommended

*

order quantity, Q . cu is the cost of underestimating demand (having lost sales because of a stockout)

and co is the cost per unit of overestimating demand (having unsold inventory). Specialty will sell

Weather Teddy for $24 per unit. The cost is $16 per unit. So, cu = $24 - $16 = $8. If inventory

remains after the holiday season, Specialty will sell all surplus inventory for $5 a unit. So, co = $16 -

$5 = $11.

P(Demand Q* ) =

8

= 0.4211

8 + 11

0.4211

0.5789

Q*

z = -0.20

z=

Q* 20, 000

= 0.20

5102

The profit projections for this order quantity are computed below:

Order Quantity: 18,980

Sales

Unit Sales

Total Cost

at $24

at $5

CP - 21

Profit

Chapter 3

10,000

20,000

30,000

303,680

303,680

303,680

240,000

455,520

455,520

44,900

0

0

CP - 22

-18,780

151,840

151,840

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