COMM 399 Logistics and Operations Management

Summer 2013
Problem Set 3 (Group homework)
Due on June 19 (Wednesday)
Answers

Question 1
Weekly demand for DVDs at a retailer is normally distributed with a mean of 1,000 boxes
and a standard deviation of 300. Assume the following data:
• There are 50 working weeks in a year.
• Lead time for delivery of an order is 4 weeks.
• The retailer takes ownership of the product only when the product reaches the store
(i.e., the retailer is not responsible for pipeline inventory)
• Fixed cost (ordering and transportation) per order is $100.
• Each box of DVDs costs $1 to purchase.
• The cost of holding one unit for one year is 25% of the purchase cost of a box of
DVD.
• The retailer currently orders 20,000 DVDs when stock on hand reaches 4,500.

(a) What is the annual ordering cost and annual holding cost under the current policy?
(The average inventory here is cycle stock plus safety stock.)

(b) What is the service level under the current policy?

(c) How long, on average, does a DVD spend in the store?

(d) Assuming that a retailer wants the probability of stocking out in a cycle to be no
more that 5%, recommend an optimal inventory policy. In other words, what order
quantity and reorder point do you recommend?

(e) What is the annual ordering cost and holding cost now? Under your recommendation,
how long, on average, would a box of DVDs spend in store?

(f) Suppose that the retailer is considering a faster mode of transportation that would
reduce lead time to 1 week. This faster transportation model costs an additional 1 cent
per box of DVDs. How much would the retailer save in inventory costs? Is it worth
using the faster transportation mode? (Assume that the retailer still wants the
probability of stocking out in a cycle to be no more that 5%.)

1
2
 100 100050
New EOQ 12 1.01 0.25 16293

919.12
919.12

Question 2
(a) Joe is a Christmas tree vendor serving his own neighbourhood. He purchases trees for
$10 each and sells for $25 each. At the end of the holiday season, the unsold trees can
be salvaged at $3 each. From the past experience, Joe is sure about the sales
probabilities which are listed below.
Number of trees sold Probability
1 0.02
2 0.08
3 0.12
4 0.20
5 0.30
6 0.15
7 0.10
8 0.03
What is the optimal number of trees that Joe should purchase? (5 points) Calculate the
expected number of trees sold, the expected number of trees unsold, and the expected
profit. (5 points)
Number of trees sold Probability Cumulative Prob. Units sold (x=5)
1 0.02 0.02 1
2 0.08 0.10 2
3 0.12 0.22 3
4 0.20 0.42 4
5 0.30 0.72 5
6 0.15 0.87 5
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 7 0.10 0.97 5
8 0.03 1.00 5

Cu = 25 – 10 = $15
Co = 10 – 3 = $7

Cu 15
= = 0.68
Cu + Co 15 + 7

x = 4 or 5
Based on the round-up rule, the optimal x = 5 trees
Expected sales = 0.02*1+0.08*2+0.12*3+0.2*4+0.3*5+0.15*5+0.1*5+0.03*5 = 4.24
Expected trees unsold = x-Expected sales = 5-4.24 = 0.76
(Alternatively, 0.02*4+0.08*3+0.12*2+0.2*1= 0.76)
Expected profit = $25*Expected sales - $10*x + $3*Expected trees unsold
= 25*4.24 – 10*5 + 3*0.76 = $58.28

(b) You are in the revenue management department of the ABC airlines. Your job is to
decide the number of passengers to be booked on each flight from New York to Los
Angeles. Each flight has a capacity of 200 seats. The demand of this market is so high
that you can easily get all the seats booked. However, you know that from past records
some passengers with reservations will cancel their reservation or do not show up for the
flight. Assume the cost of operating the flight is sunk. Will you take more than 200
reservations? What is the trade-off between having more than 200 reservations and
having exactly 200 passengers booked? How to determine the number of reservations to
take? What information do you need? (10 points)
Yes, need to overbook, i.e. reserve more than 200 passengers
Need to know:
- Cost of overestimating one no-show: Co= penalties, loss of goodwill, cost of referring
the customer to the next flight
- Cost of underestimating one no-show: Cu= per passenger revenue (loss due to having
one seat unoccupied)
- Distribution of no-shows (x): CDF of x, i.e. Φ (z)=Pr(x<=z)
Critical value = Cu / (Cu+Co)
Determine z from the distribution, such that Φ (z)=Pr(x<=z)=critical value
e.g. suppose x~N(µ, σ)
Φ (z) = critical value!look for z value in the Normal distribution table
Number of overbooking = µ + z* σ
Total number of passengers booked = 200 + Number of overbooking
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