Exercise 1

Atkinson Hotel has a gift shop. Managing inventories has

been a problem. One of the top-selling items at the gift
shop is a bird feeder. Sales are 18 units per week. The
cost of placing an order with the supplier is $45. Annual
holding cost is $15, and the hotel operates 52 weeks
per year. Management chose a 390-unit lot size (i.e.,
quantity to be ordered at each order) so that new
orders could be placed less frequently.
(1) What is the annual cost of the current policy of using a
390-unit lot size?
(2) What lot size can achieve the minimum total annual
inventory cost (i.e., economic order quantity (EOQ))?
Fixed order quantity systems: Demand
rate is constant case (Cont.)

3000 —
Q D
Annual cost (dollars)

Total cost = (H) + (S)

2 Q

2000 — Bird feeder costs

Q
Holding cost = (H)
2

1000 —
D
Ordering cost = (S)
Q

0— | | | | | | | |
50 100 150 200 250 300 350 400
Lot Size (Q)
Fixed order quantity systems: Demand
rate is constant case (Cont.)

3000 —
Q D
Annual cost (dollars)

Total cost = (H) + (S)

2 Q

2000 — Bird feeder costs

Q
Holding cost = (H)
D = (18 /week)(52 weeks) = 936 units 2
H = $15
S = 1000
$45 — Q = 390 units
D
Q D Ordering cost = (S)
C= (H) + (S) Q
2 Q
0— | | | | | | | |
C = $2925 + $108 =150
50 100
$3033
200 250 300 350 400
Lot Size (Q)
Fixed order quantity systems: Demand
rate is constant case (Cont.)
Current
cost
3000 — Bird feeder costs
Q D
Annual cost (dollars)

Total cost = (H) + (S)

2 Q

2000 —
Q
Holding cost = (H)
2

1000 —
D
Ordering cost = (S)
Q

0— | 75 | | | | | | |
50 100 150 200 250 300 350 400
Current
2DS Lot Size (Q)
EOQ = Q
H
Fixed order quantity systems: Demand
rate is constant case (Cont.)
Current
cost
3000 — Bird feeder costs
Q D
Annual cost (dollars)

Total cost = D(H) + (S)

2 = (18Q/week)(52 weeks) = 936 units
H = $15
2000 — S = $45 Q = EOQ
Q
2DS Holding cost
Q = D(H)
EOQ = =75 C = (H) + 2 (S)
H 2 Q
1000 — = (75*15/2)+(936*45/75)
= 1124.1 D
Ordering cost = (S)
Q

0— | | | | | | | |
50 100 150 200 250 300 350 400
Current
Lot Size (Q)
Q
Fixed order quantity systems: Demand
rate is constant case (Cont.)
Current
cost
3000 — Bird feeder costs
Q D
Annual cost (dollars)

Total cost = (H) + (S)

2 Q

2000 —
Q
Holding cost = (H)
2
1124.1
1000 —
D
Ordering cost = (S)
Q

0— | 75 | | | | | | |
50 100 150 200 250 300 350 400
Current
2DS Lot Size (Q)
EOQ = Q
H
 Exercise 2

• Let us return to the bird feeder example. The cost of

placing an order with the supplier is $45. Annual holding
cost is $15, and the hotel operates 52 weeks per year.
Suppose that the average demand is 18 units per week
with a standard deviation of 5 units. The lead time is
constant at 2 weeks.
(1) Determine the safety stock and reorder point if
management wants a 90% service level - that is, the
probability of stockout is 10%.
(2) What is the total inventory cost for this fixed quantity
order system if the shop places an order of the
economic order quantity?
 Exercise 2 (Cont.)

Bird feeder Lead Time Distribution

d = 18 L=2

sL = st L =5 2 = 7.1

Safety stock = zsL = 1.28(7.1) = 9.1 units

Reorder point = dL + Safety stock

= 18(2) + 9.1 = 45.1 units
Exercise 2 (Cont.)

Bird feeder Lead Time Distribution

d = 18 L=2 EOQ =74.939

D = 18 x 52(weeks) = 936
Reorder point = 2(18) + 9.1 = 45.1 units
74.939 936
C= ($15) + ($45) + 9.1($15)
2 74.939

C = $562.049 + $562.057 + $136.5 = $1260.606

 Exercise 3

• North York Paint stocks paint in its warehouse and sells

it online. The store stocks many brands of paint. Daily
demand for Ironcoat paint is normally distributed with an
average daily demand of 30 gallons and a standard
deviation of 5 gallons of paint per day. The lead time for
receiving a new order of paint is 10 days. Determine the
reorder point and safety stock if the store wants to limit
the probability of stockout to 4.01%.
 Exercise 3 (Cont.)

Iron coat Paint Lead Time Distribution

d = 30 L = 10

sL = st L =5 10 = 15.81

Safety stock = zsL = 1.75(15.81) = 27.6675 gallons

Reorder point = dL + Safety stock

= 30(10) + 27.6675 = 327.6675 gallons

Stock out = 4.01%, i.e. Service level = 95.99% look for 0.9599 in the body of z-table, z= 1.75
 Extra Quantity Discounts Example

North York Appliances, a distributor of audio and video equipment,

plans to reduce a large stock of VCRs. It has offered a local chain
of stores a quantity discount pricing schedule, as follows:

ORDER SIZE PRICE

1- 49 $1400
50 – 89 $1100
90+ $900

The annual carrying cost (or, holding cost) for the stores for a VCR is
$190, the ordering cost (or, set up cost) is $2,500, and annual
demand for this model VCR is 200 units. The chain wants to
determine if it should take advantage of this discount or order the
EOQ (economic order quantity).
 Quantity Discount Example
QUANTITY PRICE
S = $2,500
1 - 49 $1,400 H = $190 per TV
50 - 89 1,100
D = 200 TVs per year
90+ 900

2SD 2(2500)(200)
Qopt = = = 72.5 TVs
H 190

For Q = 72.5 SD HQopt

TC = + 2 + CD = $233,784
Qopt

For Q = 90 SD HQ
TC = + 2 + CD = $194,105 so order 90.
Q