CHAPTER 12

DISCUSSION QUESTIONS

1. The advent of low-cost computing should not be seen as obviating the need for the ABC inventory
classification scheme. Although the cost of computing has decreased considerably, the cost of data
acquisition has not decreased in a similar fashion. Business organizations still have many items for
which the cost of data acquisition for a perpetual inventory system is still considerably higher
than the cost of the item.

2. The standard EOQ model assumes instantaneous delivery (delivery of the entire lot is made at one
instant of time), whereas the Production Inventory Model assumes that delivery takes place at a
constant rate over time.

3. Reasons for an organization to maintain inventory include:

n The decoupling function:
inventory can be used to decouple stages in the production process within an
organization
inventory can be used to decouple the production process from instabilities or
irregularities in supply of raw materials or labor
inventory can be used to decouple the production process from unstable demand and
thus (a) allow production scheduling to develop a smoother schedule, and (b) avoid
shortages or stockouts
n Quantity discounts:
inventory can be used to enable the organization to purchase goods in larger lot sizes
and take advantage of quantity discounts
n A hedge against inflation:
investing in inventory now assures one that the price will not increase

4. Costs that are associated with ordering and maintaining inventory include:
n Initial purchase cost of the item
n Holding cost (insurance, space, heat, light, security, warehouse personnel, etc.)
n Obsolescence or deterioration cost (particularly important in perishable goods or in a product
that is undergoing rapid technological evolution)
n Ordering or setup cost (cost of forms, clerical processing, etc., or cost of machine setup)

5. The more important assumptions of the basic EOQ model are:

n Demand is known and constant over time.
n The lead time, that is, the time between the placement of the order and the receipt of the
goods, is known and constant.
n The receipt of the inventory is instantaneous; i.e., the goods arrive in a single batch, at one
instant in time.

Chapter 12: Inventory Management 1

 n Quantity discounts are not possible.
n The only variable costs are the cost of setting up or placing an order and the cost of holding
or storing inventory over time.
n If orders are placed at the right time, stockouts or shortages can be completely avoided.

6. The EOQ is relatively insensitive to small changes in demand or setup or carrying costs. If, for
example, demand increases by 10%, EOQ will increase by approximately 5%.

9. A decrease in setup time decreases the cost per order, encourages more and smaller orders, and thus
decreases the EOQ.

12. If per unit holding costs increase with increasing inventory, total inventory cost will increase; EOQ
will decrease.

14. In a fixed-quantity inventory system, when the quantity on hand reaches the reorder point, an order
is placed for the specified quantity. In a fixed-period inventory system, an order is placed at the end
of the period. The quantity ordered is that needed to bring on-hand inventory up to a specified level.

END-OF-CHAPTER PROBLEMS

12.2 He decides that the top 20% of the 10 items, based on a criterion of demand times cost per unit,
should be A items. (In this example, the top 20% constitutes only 58% of the total inventory value,
but in larger samples the value would probably approach 70% to 80%.) He therefore rates items F3
and G2 as A items. The next 30% of the items are A2, C7, and D1; they represent 23% of the value
and are categorized as B items. The remaining 50% of the items (items B8, E9, H2, I5, and J8)
represent 19% of the value and become C items.

Item Annual Demand Cost ($) Demand Cost Classification

A2 3,000 50 150,000 B
B8 4,000 12 48,000 C
C7 1,500 45 67,500 B
D1 6,000 10 60,000 B
E9 1,000 20 20,000 C
F3 500 500 250,000 A
G2 300 1,500 450,000 A
H2 600 20 12,000 C
I5 1,750 10 17,500 C
J8 2,500 5 12,500 C

12.3 Item Annual Demand Cost ($) Demand Cost Classification

E102 800 4.00 3,200 C
D23 1,200 8.00 9,600 A 27%
D27 700 3.00 2,100 C
R02 1,000 2.00 2,000 C
R19 200 8.00 1,600 C
S107 500 6.00 3,000 C
S123 1,200 1.00 1,200 C
U11 800 7.00 5,600 B 16%
U23 1,500 1.00 1,500 C 33%
V75 1,500 4.00 6,000 B 17%
12.4 7,000 0.10 700 700 20 35 35 A items per day
7,000 0.35 2,450 2450 60 40.83 41 B items per day
7,000 0.55 3,850 3850 120 32 35 C items per day
108 items

2 Instructors Solutions Manual t/a Operations Management

 2 1000 62.50
12.5 EOQ 500 units
0.50

28,000 45
12.6 EOQ 600 units
2

28,000 45 720,000
12.7 300 90,000
H H
720,000
H $8
90,000

12.8 (a) Economic Order Quantity (Holding cost = $5 per year):

2 DS 2 400 40
Q 80 units
H 5

where: D = period demand, S = setup or order cost, H = holding cost

(b) Economic Order Quantity (Holding cost = $6 per year):

2 DS 2 400 40
Q 73 units
H 6

where: D = period demand, S = setup or order cost, H = holding cost

12.9 (a) Economic Order Quantity:

2 DS 2 1,500 150
Q 100 units
H 45

where: D = period demand, S = setup or order cost, H = holding cost

QH 100 45
(b) Holding cost $2,250.00
2 2
DS 1500 150
(c) Order cost $2,250.00
Q 100
(d) Reorder point:
1,500
Reorder point = demand during lead time units day 6 days 30 units
300

12.10 Reorder point = demand during lead time 100 units day 21 days 2,100 units

12.11 Reorder point = demand during lead time 500 units day 14 days 7,000 units

12.12 (a) Economic Order Quantity:

2 DS 2 4,000 25
Q 1491
. or 149 valves
H 0.10 90

where: D = period demand, S = setup or order cost, H = holding cost

(b) Average inventory 74.5 valves

Demand 4,000
(c) Number of orders per year 26.8 or 27 orders
EOQ 149
(d) Assuming 250 business days per year, the optimal number of business days between orders is
given by:

Chapter 12: Inventory Management 3

 250 1
Optimal number of days 9 days
27 4

(e) Total annual inventory cost Order cost holding cost

DS QH 4,000 25 149 01
. 90

Q 2 149 2
67114
. 670.50 $1,341.64
Note: Order and carrying costs are not equal due to rounding of the EOQ to a whole number.
(f) Reorder point = demand during lead time 16 units day 5 days 80 valves

12.13 (a) Economic Order Quantity:

2 DS 2 5,000 30
Q 77.46 or 78 units
H 50

where: D = period demand, S = setup or order cost, H = holding cost

78
(b) Average inventory 39 units
2
Demand 5,000
(c) Number of orders per year 641. or 64 orders
EOQ 78
(d) Assuming 250 business days per year, the optimal number of business days between orders is
given by:

250
Optimal number of days 3.91 days
64

(e) Total cost order cost holding cost

DS QH 5,000 30 78 50

Q 2 78 2
1,923.02 1,950 $3,873.08
Note: Order and carrying costs are not equal due to rounding of the EOQ to a whole number.
If an EOQ of 77.46 is used, the order and carrying costs calculate to $1,936.49 for a total
cost of $3,872.98.
(f) Reorder point:

5,000 units
Reorder point = demand during lead time 10 days 200 units
250 days

This is not to say that we reorder when there are 200 units on hand (as there never are). The
ROP indicates that orders are placed several cycles prior to their actual demand.

12.14 (a) Economic Order Quantity:

2 DS 2 1,200 25
Q 50 units
H 24

where: D = period demand, S = setup or order cost, H = holding cost

DS QH
(b) Total cost = order cost + holding cost
Q 2

1,200 25 25 24
For Q 25 : $1,500
25 2

4 Instructors Solutions Manual t/a Operations Management

 1,200 25 40 24
For Q 40 : $1,230
40 2
1,200 25 50 24
For Q 50 : $1,200
50 2
1,200 25 60 24
For Q 60 : $1,220
60 2
1,200 25 100 24
For Q 100 : $1,500
100 2

As expected, small variations in order quantity will not have a significant effect on total
costs.

DS QH
12.15 (a) Total cost = order cost + holding cost
Q 2
For Q 50 :

600 60 50 20
720 500 $1,220
50 2

(b) Economic Order Quantity:

2 DS 2 600 60
Q 60 units
H 20

where: D = period demand, S = setup or order cost, H = holding cost

For Q 60 :

600 60 60 20
600 600 $1,200
60 2

(c) Reorder point:

600 units
Reorder point = demand during lead time 10 days 24 units
250 days

12.16 Economic Order Quantity, noninstantaneous delivery:

2 DS 2 10000 200
Q 2309.4 units
H [1 ( d / p ) 50
1.00 1
200

where: D = period demand, S = setup or order cost, H = holding cost, d = daily demand rate, p =
daily production rate

12.17 Economic Order Quantity, noninstantaneous delivery:

2 DS 2 8000 100
Q 1651.4 units
H [1 ( d / p ) 40
0.80 1
150

where: D = period demand, S = setup or order cost, H = holding cost, d = daily demand rate, p =
daily production rate

12.18 (a) Economic Order Quantity, noninstantaneous delivery:

2 DS 2 10000 40
Q 1217.2 units
H [1 ( d / p ) 50
0.60 1
500

Chapter 12: Inventory Management 5

 where: D = period demand, S = setup or order cost, H = holding cost, d = daily demand rate,
p = daily production rate
d 50
(b) I Q 1 1217.2 1 1095.5 units
max p 500

D 10,000
(c) 8.22
Q 1,217
I D
(d) T . C. max H S 328.50 328.80 657.30
2 Q

12.19 Economic Order Quantity:

2 DS
Q
H

where: D = period demand, S = setup or order cost, H = holding cost, P price/unit

(a) Economic Order Quantity, standard price:

2 2,000 10
Q 200 units
1
Total cost order cost holding cost purchase cost
DS QH 2,000 10 200 1
PD 2,000 1 100 100 2,000 $2,200
Q 2 200 2

(b) Quantity Discount:

Total cost order cost holding cost purchase cost

DS QH 2,000 10 2,000 1
PD 2,000 0.75
Q 2 2,000 2
10 1,000 1,500 $2,510

Note: No, EOQ with 200 units and a total cost of $2,200 is better.

12.20 Under present price of $50.00 per unit, Economic Order Quantity:

2 DS
Q
H
2 1,000 40
Q 80 units
0.25 50

where: D = period demand, S = setup or order cost, H = holding cost, P price/unit

Total cost order cost holding cost purchase cost

DS QH 1,000 40 80 0.25 50
PD 1,000 50
Q 2 80 2
500.00 500.00 50,000 $51,000
Under the quantity discount price reduction of 3%:

6 Instructors Solutions Manual t/a Operations Management

 Total cost order cost holding cost purchase cost
DS QH 1,000 40 200 0.25 50 0.97
PD 1,000 50 0.97
Q 2 200 2
200.00 1212.50 48,500 $49,912.50

Therefore, the pumps should be ordered in batches of 200 units and the quantity discount taken.

12.21 Under present price of $7.00 per unit, Economic Order Quantity:

2 DS
Q
H
2 6,000 20
Q 4781
. or 478 units
0.15 7

where: D = period demand, S = setup or order cost, H = holding cost, P price/unit

Total cost order cost holding cost purchase cost

DS QH 6,000 20 478 0.15 7
PD 7 6,000
Q 2 478 2
251.05 250.95 42,000 $42,502.00

Note: Order and carrying costs are not equal due to rounding of the EOQ to a whole number.
Under the quantity discount price of $6.65 per unit:

Total cost order cost holding cost purchase cost

DS QH 6,000 20 3,000 015
. 6.65
PD 6,000 6.65
Q 2 3,000 2
40.00 1,496.25 39,900 $41,436.25

Therefore, the new policy, with a total cost of $41,436.25, is preferable.

12.22 Economic Order Quantity:

2 DS
Q
H

where: D = period demand, S = setup or order cost, H = holding cost, P price/unit

(a) Economic Order Quantity, standard price:

2 45 10
Q 30 units
0.05 20

Total cost order cost holding cost purchase cost

DS QH 45 10 30 0.05 20
PD 45 20
Q 2 30 2
15 15 900 $930

(b) Quantity Discount, 75 units or more. Economic Order Quantity, discount over 75 units:

2 45 10
Q 3119
. or 31 units
0.05 18.50

Chapter 12: Inventory Management 7

 Because EOQ = 31 and a discount is given only on orders of 75 or more, we must calculate
the total cost using a 75-unit order quantity:

Total cost order cost holding cost purchase cost

DS QH 45 10 75 0.05 18.50
PD 45 18.50
Q 2 75 2
6 34.69 832.50 $873.19

(c) Quantity Discount, 100 units or more; Economic Order Quantity, discount over 100 units:

2 45 10
Q 33.81 or 34 units
0.05 15.75

EOQ = 34 and a discount is given only on orders of 100 or more, thus we must calculate the
total cost using a 100-unit order quantity. Calculate total cost using 100 as order quantity:

Total cost order cost holding cost purchase cost

DS QH 45 10 100 0.05 15.75
PD 45 15.75
Q 2 100 2
4.5 39.38 708.75 $752.63

Based purely upon cost, the decision should be made to order in quantities of 100, for a total
cost of $752.63.
It should be noted, however, that an order quantity of 100 implies that an order will be
placed roughly every two years. When orders are placed that infrequently, obsolescence may
become a problem.

12.23 Economic Order Quantity:

2 DS
Q
H

where: D = period demand, S = setup or order cost, H = holding cost, P price/unit

(a) Order quantity 9 sheets or less, unit price = $18.00

2 100 45
Q 50 units
0.20 18

Total cost order cost holding cost purchase cost

DS QH 100 45 50 0.20 18
PD 18 100
Q 2 50 2
90 90 1,800 $1,980 see note at end of problem re. actual price

(b) Order quantity 10 to 50 sheets: unit price = $17.50

2 100 45
Q 50.7 units or 51 units
0.20 17.50
Total cost order cost holding cost purchase cost
DS QH 100 45 51 0.20 17.50
PD 17.50 100
Q 2 51 2
88.23 89.25 1750.00 1927.48

8 Instructors Solutions Manual t/a Operations Management

 Note: Order and carrying costs are not equal due to rounding the EOQ to a whole number.
See note at end of problem regarding price.
(c) Order quantity more than 50 sheets: unit price = $17.25

2 100 45
Q 511
. units or 51 units
0.20 17.25
Total cost order cost holding cost purchase cost
DS QH 100 45 51 0.20 17.25
PD 17.25 100
Q 2 51 2
88.24 87.98 1,725.00 $1,901.22

Therefore, order 51 units.

Note: Order and carrying costs are not equal due to rounding of the EOQ to a whole
number.
Important Note: Calculations of total cost under (a) and (b) are actually inappropriate
because the original assumptions as to lot size would not be satisfied by the calculated EOQs.

12.24 D 700 12 , H 5, S 50

Allen
1499 $16.00
500999 $15.50
1000+ $15.00

Baker
1399 $16.10
400799 $15.60
800+ $15.10

2 DS 28,400 50
Q 409.88 410
H 5

Vendor: Allen

410 8,400
at 410, TC 5 50 8,400 16 $136,449.36
2 410
500 8,400
at 500, TC 5 50 8,40015.5 $132,290
2 500
1,000 8,400
at 1000, TC 5 50 8,400 15 $128,920 BEST
2 1,000

Vendor: Baker

410 8,400
at 410, TC 5 50 8,40015.60 $133,089.39
2 410
800 8,400
at 800, TC 5 50 8,4001510
. $129,365
2 800

Chapter 12: Inventory Management 9