3. What is the purpose of the ABC classification system?

The purpose of the ABC system is to identify those items that require more attention due to cost or
volume.

ABC classification is closely associated with the 80/20 rule, a business metric that proposes 80% of the
outcomes are determined by 20% of the inputs. The goal of ABC classification is to provide a way for a
business to identify that valuable 20% so that segment can be controlled most closely. Once the A’s, B’s
and C’s have been identified, each category can be handled in a different way, with more attention being
devoted to category A, less to B, and even less to C.

ABC classification is most often associated with inventory control, but the system can also be used to
rank things such as which customers are most important, which business segments cause the most
financial risk, which employees are most valuable or which parts of a process are most likely to cause a
bottleneck.

7. Explain why it is not necessary to include product cost (price or price times quantity) in the EOQ
model, but the quantity discount model requires this information.

Price times quantity is not variable in the EOQ model but it is variable in the discount model. When
quantity discounts are available, the unit purchase price of the item depends on the order quantity.

10. When quantity discounts are offered, why is it not necessary to check discount points that are below
the EOQ or points above the EOQ that are not discount points?

Discount points below the EOQ have higher inventory costs, and the prices are no lower than at the
EOQ. Points above the EOQ have higher inventory costs than the corresponding price breaks or the EOQ
(it depends on whether there exists a discount point above the EOQ).

16. When demand is not constant, the reorder point is a function of what four parameters?

The reorder point is a function of: Demand per unit of time, lead time, customer service level, and
standard deviation of demand.

12.12

Holding cost, H = $35 per unit

Ordering cost, S = $121 per order

Demand per year = 400 × 12

= 4,800

(a) Optimal order quantity(Q): = 182.17

(b) Minimum/Total cost = Holding cost + Purchasing cost + Ordering cost

Total cost = (Q ÷ 2) × H + (p × Q) + (D ÷ Q) × S

As the EOQ is 181 -- in the range of 100-199 units, the purchasing cost/unit (p) = 325 $/unit

Total cost = (182 ÷ 2) × 35 + 4,800 × 325 + (4,800 ÷ 182) × 120

= $3,185 + $1,560,000 + $3,165

= $1,566,350 (approx)