Inventory Models

Management Science
 Inventory Management

• Inventory vs. Inventory Management

• Objective of Inventory Management
To determine the “ideal” level of inventory to
minimize costs.
 Inventory Management

• Two important questions to answer.

1. How much to order?
2. When to order?
 Inventory Management

• Reasons why companies holds or stocks

inventories
1. Customer Service
2. Economies of Purchasing and Production
3. Hedge against unforeseen events
 Inventory Management

• Disadvantages of holding inventories

1. Storage Costs
2. Deterioration
 Inventory Management

• Basic Costs Associated with Managing

Inventories
1. Ordering Costs
2. Holding/Carrying Costs
3. Stock Out Costs
 Inventory Management

• Tools use in managing inventories

Inventory Models
1. Economic Order Quantity
2. Quantity Discount Model
3. Re-order Point
4. Economic Lot Size
 Economic Order Quantity

• It is the ideal quantity a company should

place every order to minimize inventory
costs.
• How much to order decision
 Economic Order Quantity

• Assumptions in EOQ Model

Demand occurs at a constant rate
throughout the year.
Lead time does not vary and each order is
received in a single delivery.
Unit costs is constant, thus there can be no
quantity discounts.
The size of inventory is not limited.
 Economic Order Quantity

• Two problems may arise

1. Keeping small inventories and ordering
frequently can result to undesirably high
ordering costs.
2. Keeping large inventories and ordering
infrequently can result to undesirably high
holding/carrying costs.
 Economic Order Quantity Formula

2 × 𝐴𝐷 × 𝑂𝐶
𝐸𝑂𝑄 =
𝐶𝐶
• AD = Annual Demand
• OC = Ordering Cost
• CC = Holding/Carrying Cost
 Economic Order Quantity

Janny and Bayo Furnitures buys special woods from the outside suppliers at P400 per set. Total
annual needs are 5,000 sets per working day. The following cost data are available:

Desired Annual Returns on inventory investment (10% @ P400) P40

Rent, Insurance, and Taxes per unit P10

Annual Carrying Cost P50

Cost of Ordering P50

Required:

A. Computed EOQ.

B. Compute annual ordering costs.

C. Compute annual carrying costs.

 Quantity Discount Model

• Considers quantity discount

• The major trade off when considering quantity discounts is
between the reduced unit costs and increased carrying
costs.
 Re-order Point

• It is the inventory level or position at which a new order

should be placed.
• When to order decision
• “Signal” point
 Re-order Point

• Things to consider
1. Usage Rate
2. Lead Time
- the time between the placing of an order and its
receipt in the inventory system.
3. Safety Stock
 Cycle Time

• The length of time between the placing of two

consecutive orders.
𝐴𝑛𝑛𝑢𝑎𝑙 𝑊𝑜𝑟𝑘𝑖𝑛𝑔 𝐷𝑎𝑦𝑠
𝑐𝑦𝑐𝑙𝑒 𝑡𝑖𝑚𝑒 =
𝑁𝑜. 𝑜𝑓 𝑂𝑟𝑑𝑒𝑟𝑠 𝑝𝑒𝑟 𝑦𝑒𝑎𝑟
 Re-order Point

• The following information is available for Magandang Deelag Corporation:

Annual Demand (in units) 100,000

Working Days per Year 250 days

Normal Lead Time in Working Days 3 days

Required:

1. Compute Magandang Deelag’s Re-order Point

2. Compute Magandang Deelag’s safety stock level and re-order point if based on experience its
maximum lead time is 7 working days.

3. What is the cycle time?

 Economic Lot Size

• It is the ideal quantity a company should produce to

minimize inventory costs.
• TSC = TCC
 Economic Lot Size

2 × 𝐴𝐷 × 𝑆𝐶 𝑃𝐷
𝐸𝐿𝑆 = ×
𝐶𝐶 𝑃𝐷 − 𝐷𝐷

• AD = Annual Demand
• SC = Set Up Costs
• CC = Carrying Costs
• PD = Production per day
• DD = Daily Demand
 Economic Lot Size

Annual Set Up Costs

𝐴𝑛𝑛𝑢𝑎𝑙 𝐷𝑒𝑚𝑎𝑛𝑑
𝑇𝑂𝐶 = × 𝑂𝐶 𝑝𝑒𝑟 𝑜𝑟𝑑𝑒𝑟
𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦
Annual Carrying Cost
𝑃𝐷 − 𝐷𝐷
𝑇𝐶𝐶 = 𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝐼𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑦 ∗ × × 𝐶𝐶 𝑝𝑒𝑟 𝑢𝑛𝑖𝑡
𝑃𝐷

∗
𝑄𝑢𝑎𝑛𝑡𝑖𝑡𝑦 ÷ 2
Reference:
Anderson, D., Sweeney, D.,
et.al.(2018). An Introduction to
Management Science Quantitative
Approaches to Decision Making
14ed. Cengage.
Prepared by:
John Melvin V. Baranda