INVENTORY CONTROL SYSTEMS

INVENTORY CONROL SYSTEMS

1. Nandu Lal is a vendor of fruits in a remote village in the hills of Garhwal. Every
three days, a truck from the local Farmers’ Association arrives at the village to
bringing a fresh stock of fruits. Nandu Lal buys bananas from the vendor for Rs. 25
per kg and sells them at Rs. 40 a kg. The supplier offers the bananas in bundles of 5
kg only and Nandu Lal purchases 4 bundles during each supplier visit. Usually, all
the bananas are sold but if there are leftovers, Nandu Lal sells them to a restaurant
in the neighbouring town for Rs. 15 a kg, for use in making sweet dishes. Recently,
there has been an increasing interest in sports, fitness and a healthy lifestyle and
Nandu Lal has started seeing more demand than the quantity he stocks. A study has
revealed the demand for bananas in each three-day period between supplier visits
follows the distribution given below.

Period demand (kg) 10 15 20 25 30 35 40

Probability 0.10 0.10 0.12 0.14 0.16 0.18 0.20
a. What is Nandu Lal’s current service level?
b. In how many 3-day periods in a year of 360 days can Nandu Lal expect to have a
stockout?
c. What is the optimal service level?
d. How many bundles should Nandu Lal purchase in order to maximize
profitability?

2. Meena Bai and her son eke out a living by making and selling samosas on the
roadside near the Dadar railway station in Mumbai. An NGO, who sympathizes
them and wants to help them in some way, assesses that the daily demand for
samosas at their road-side stall is distributed as a normal distribution with a mean
of 140 and a standard deviation of 20. So, Meena Bai and her son prepare 140
samosas each day, between 3 pm and 5 pm and sell them between 5 pm and 8 pm at
Rs. 10 per piece. On good days, all samosas are sold well before 8 pm, but there are
also bad days on which many samosas remain unsold and cannot be kept for next
day’s sales. Since their samosas are very tasty, a nearby late-night canteen has
purchases all their unsold samosas for Rs. 3 per piece. Though it costs Meena Bai Rs.
5 to make a samosa, something is better than nothing.
a. What is their current service level?
b. On how many days can she expect to have a stockout in a month of 30 days?
c. What is the optimal service level to maximize her profitability?
d. How many samosas should Meena Bai prepare daily ?

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3. Rakesh Maheshwari, an MBA student starts a business of renting bicycles to fellow

students for use in travelling outside the campus. A bicycle can be hired only for a
full day’s (morning to night) use, because of which, it can be hired only once a day.
Rakesh estimates that the daily demand will be distributed as follows:
Hires
Prob
/ day
0 0.05
1 0.1
2 0.15
3 0.2
4 0.25
5 0.2
6 0.05
After considering the purchase price of a bicycle and its overhaul and maintenance
costs, and taking its usable lifetime to be the two-year MBA period, Rakesh estimates
a bicycle’s cost per day to be Rs. 25. If the number of optimal bicycles to invest in
must be 4, how much should he charge per hire?

4. For a special ingredient used in the manufacturing of tyres at Speed Tyres Ltd,
Chennai, yearly consumption follows a normal distribution with a mean of 32000 kg
and a standard deviation of 1000 kg, while the lead-time for replenishment is a
constant 5 working days for any order. The price of the ingredient is Rs. 200 per kg
and its annual holding cost per kg is 15% of its unit price in Rs. The order cost is Rs.
3000 per order. Backordering is permitted; the backorder cost is Rs. 570 per kg per
year. Speed Tyres works 320 days in a year.
a. Find the optimal order quantity and service level, using a suitable EOQ model.
b. What should re-order point (r*) be to set up a (Q, r) system and what is the safety
stock (s)?
c. With the above, for what proportion of time will there be a stock-out?
d. What is the mean optimal time between orders, in working days?

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5. The demand for a popular USB thumb drive at Modern Electronics is found to be
normally distributed with a mean of 18 units per week and a variance of 9. The
lead-time to replenish is 4 weeks and the business operates 50 weeks a year. The
inventory holding cost is Rs. 15 per unit per year, and the cost of placing an order is
Rs. 120. If a P system has to be followed with a service level of 98%, determine
a. the optimal average order quantity.
b. the review and protection periods (in weeks).
c. the average safety stock.
d. the target inventory level.
e. the average re-order point.
f. the average of the maximum cycle inventory.

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6. Gunjan Arora, the Chief Manager of X-Mart, a large superstore, is planning to set up
an inventory control system for a particular SKU of toothpaste. The unit value of the
toothpaste SKU is Rs. 10. Past data shows that the daily consumption of the SKU
follows a normal distribution with a mean of 6 and a standard deviation of 1 unit.
Backordering is not possible with such an item, since, a stockout implies that a
customer will not wait for the replenishment, but will purchase an alternate, or seek
the item elsewhere. The lead-time to replenish is 3 days. The annual unit holding
cost is 30% of the SKU’s value and the order cost is Rs. 100 per order. X-Mart works
324 days a year and wishes to have a 98% service level for all its items.
If the continuous review inventory control system is followed,
a) Find the optimal order quantity.
b) What should re-order point (r*) be, to set up a (Q, r) system?
c) What is the average safety stock?
d) For what proportion of time is there a stock-out?
e) What is the average time between orders, in working days?
Instead of the continuous review system, if X-Mart were to follow a periodic review
system for this SKU, what is
a) the optimal average order quantity?
b) the time between orders – the review period – in working days?
c) the protection period (protection interval)?
d) the average safety stock?
e) the target (order-up-to) inventory level?
f) the average re-order point?
What are the similarities and differences in the two control systems? Which system
is more suitable for this item and why?

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7. A distributor of ELGi Air Compressors in Bangalore stores a particular SKU of 15

hp compressor pumps. It experiences daily demand for the compressors,
distributed as:
Demand 0 1
Probability 0.4 0.6
The holding cost of this SKU is Rs. 15000 per unit per year and the backorder cost is
Rs. 12000 per unit per year. Assume that a year has 300 working days. The
distributor replenishes his stock from the manufacturer’s (ELGi) warehouse and the
reorder cost is negligible. The lead-time for replenishment, however, is 7 days. If
the distributor follows the base stock system, then, what is the optimal?
a. Stock-out probability?
b. Service level?
c. Inventory position?
d. Re-order point.
e. If the manager decides to have a service level of 97%, then what is the new re-
order point?

8. Pleasing Visuals, a retail store, in Itanagar sells laptops of various brands and
models. Since laptops are high value products, Planning Visuals manages its
inventory very carefully to ensure that, at any time, it neither stocks too many units
(and incurs high holding costs), nor too few (and loses its customers to
competitors). The system it follows is to place an order with its local distributors at
the end of each working day, for each SKU, equal to the number of units sold on that
day of that SKU. The distributor arranges to acquire the items from a central
stockist for the Northeast region located in Guwahati, and the lead-time to
replenishment is 8 working days. For these reasons, Planning Visuals follows the
base-stock inventory system.
The manager of Planning Visuals is now working on the re-order point for the Dell
Inspiron 14-inch laptop. He assesses that its holding cost is Rs. 8000 per unit per
year, and its backorder cost is Rs. 24000 per unit per year. Based on the data for the
last one year, he decides to model future daily demand as either 0 or 1 units, with a
probability of 0.26 for the latter. What is the optimal
a) stock-out probability?
b) service level?
c) inventory position?
d) re-order point?
e) if the manager decides to have a service level of 99%, then what is the new re-
order point?

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9. To ensure that they don’t miss their flights, many passengers of early morning
flights prefer to arrive at the departure airport the previous night itself and spend
the night there. Roshni Chetan Kumar, the Airport Manager of an airport in India,
is planning a night-halt lounge at her airport. The lounge will consist of a large hall
with adequate space, airconditioning and wash room facilities. The hall will be
partitioned into several individual cubicles and each cubile will equipped with a bed,
a reading lamp, three charging points and a locker, and be allocated to one
passenger for a 12-hour period (8 pm to 8 am). The lounge will also provide easy
access to a nearby airport restaurant. In the first phase, the lounge will be only for
women; but later, a separate lounge will be constructed for men.
After carefully gathering and analyzing pertinent data, Roshni estimates that the
daily demand from women passengers for the night lounge will follow a Poisson
distribution with a mean of 8.7. Roshni estimates that she can charge Rs. 1200 per
night for a cubicle, while the variable cost per cubicle depends on whether it is
occupied or not. Regardless of occupancy, a fixed cost of Rs. 100 per cubicle per
night arises from cubicle-specific cleaning, wear-and-tear and maintenance; this cost
will not be incurred if the cubicle was not constructed at all. When occupied, a
cubicle costs an additional Rs. 200 owing to the use of electricity, washing of used
towels and linen, a complimentary water bottle, soap and other goodies. If the
objective is to maximize the expected profit per night,
a) What is the optimal number of cubicles that Roshni should set up? Assume that
there is enough space available for as many cubicles as she wants.
b) What is the expected demand per night?
c) What is the expected occupancy per night for the above number of cubicles?
d) What is the expected profit per night for this solution? (use MS Excel)
e) [optional exercise for deeper understanding, not for exam]: Construct an Excel
spreadsheet that computes the expected profit for each combination of demand
and number of cubicles. Vary daily demand from 0 to 27 along the rows and
number of cubicles from 0 to 27 along the columns. Use a separate column to
compute the respective probabilities associated with each demand value, using
the given distribution. Total each column to obtain the expected profit realized
with the number of cubicles represented by that column. Compare the
expected profit values across the columns to check whether the best expected
profit is obtained with the optimal number of cubicles obtained in (a).

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(Part 2, not optional): Beyond the above mentioned costs, a fixed cost of running the
hall is incurred owing to the cost of space, infrastructure, airconditioning, cleaning
and maintenance and depends on the size of the hall. After discussing with
consultants, Roshni estimates the fixed costs per night for five potential hall sizes,
expressed in terms of the maximum number of cubicles the hall can hold, as follows:

Hall size (maximum cubicles) 5 10 15 25 40

Fixed costs per night (Rs.) 2000 3800 5200 6000 8000

f) Now, what is the optimal number of cubicles after taking this fixed cost into
consideration? How much expected profit per night does it yield?

10. Central India Airlines operates a commuter flight between Nagpur and Bengaluru.
The plane can hold 320 passengers and the airline charges a constant Rs. 3000 per
ticket. For a long time, the airline sold exactly 320 advance tickets for the flight.
The data shows that, cancellations happen on each flight following a normal
distribution with a mean of 18 and a standard deviation of 3. Cancellations are
given a refund of Rs. 1500 and the airline does not get any replacement for a
cancellation. Hence, the airline is considering an overbooking policy that will imply
taking a fixed number of extra bookings (over 320) for each flight. Here, the airline
also knows that if a booked passenger turns up for the flight and is denied travel
because of lack of seats, it will have to refund that person the full ticket charges and
also an extra compensation of Rs. 250. In addition, there is a loss of reputation and
goodwill with customers, which the airline has computed to be equivalent to
another Rs. 250. For simplicity, assume that the requests for bookings on this flight
are much larger than 320. Given all this,
a) What is the optimal overbooking policy?
Hint: Model this as a single-period inventory model. Here, Q is known as 320. Let the
number of bookings that we make (as a fixed policy) = x. Then, the demand (d) is the
number of bookings available (to travel on the flight) after the cancellations. We are
given that cancellations follow N(18, 3). Hence, d = x – N(18, 3). Since x is a constant,
this means that d follows a normal distribution with mean x – 18 and standard deviation 3.
Given all this, identify the costs of shortage and excess, find SL* and then compute x.