Problem Set 6

1. Review the Chapter 7 reading.

2. Complete Exercises 7.1, 7.2, and 7.3 on page 184 of the textbook.
3. Then read the following scenario and answer the questions that follow it:

SCENARIO
The Forest Stewardship Council (FSC) was formed in 1993 to promote sustainable
management of the world’s forests. The FSC quickly began to certify lumber based
on whether the forest that it was taken from was managed according to its
guidelines. Soon thereafter, several builders in California began to specialize in the
construction of “Green” buildings that only used FSC-certified lumber. This was
seen as a viable business because some customers were willing to pay a premium to
have their projects completed with FSC lumber. These builders have an opportunity
to order this lumber once every 3 months because the forests involved must be
harvested in accordance with certain restrictions. Consequently, builders who
focused on this market were forced to hold large inventories. On the other hand,
builders who only used “traditional” wood which was not FSC-certified could order
on a just-in-time basis, meaning they did not have to hold any lumber in their own
lumberyards. Consider the following 3 scenarios and related questions.

1. A green builder must decide how much FSC lumber to purchase to meet
demand for the next 3 months. Demand is normally distributed with a mean of
40,000 board-feet and a standard deviation of 15,000 board feet. (A board-foot is a
standard unit for lumber.) The purchase price for the builder is $4.00 per board-
foot. At the end of a 3-month period the wood will dry and may warp, reducing its
value. Of any lumber remaining in the builder’s lumber yard at the end of the 3-
month period, approximately half will be worthless. The builder will use any wood
that is not warped in the next period. However, buying the wood now, rather than in
the next period incurs a holding cost of 4% of the purchase cost. If the builder has
too little FSC certified wood to meet demand, he will be forced to substitute
traditional lumber which he can buy for $3.35 per board foot. In addition, the green
builder assigns a shortage cost of $2.00 per board foot for the loss of good will and
damage to his reputation. How many board feet of FSC certified lumber should the
builder purchase?
2. Suppose a lumber-yard (Nice Lumber) agrees to serve as a distributor for a
builder. This means Nice Lumber will stock the FSC-certified lumber for one green
builder. Nice Lumber will pay $4.00 per board foot for FSC-certified wood and sell it
to the builder for $4.20 per board foot. If demand exceeds the inventory, the green
builder will buy traditional wood from a different lumber yard to meet the demand
at price of $3.20 per board-foot. In addition to the lost sale, Nice assigns a cost of
$2.00 per board foot of shortage of FSC lumber. If the inventory of FSC-certified
lumber exceeds demand, Nice will immediately substitute the excess FSC certified
lumber to meet demand from other customers and reduce its purchases of
traditional lumber accordingly. Nice pays $3.20 per board foot for traditional
lumber. How many board feet of FSC certified lumber should Nice Lumber
purchase?
3. Suppose Nice Lumber will stock the FSC certified lumber for 10 green
builders. For each of these builders, demand is normally distributed with a mean of
40,000 board feet and a standard deviation of 15,000 board feet, and each builder’s
demand is independent of other builders’ demand. How many board feet of FSC
certified lumber should Nice lumber purchase per builder?

4. Submit your completed responses in a PDF document. Be sure to show your

work.