Assosa University

Department of Mechanical Engineering

Industrial Management & Engineering Economy – Materials management

Chapter – Four
Inst. Fekadu G.
Lecture time
Lecture time
Monday_ 8:00-10:00
Monday_ 8:00-10:00
Wednesday _2:00-4:00
Wednesday _2:00-4:00
Objectives
- You be able to define purchasing
- You will be able to understand basic concepts of inventory and
inventory control models
Reading assignment
• Purchasing
Inventory control – known demand
You have to decide

• What items should be in inventory (stock)?

• When should an order be placed to replenish inventory?
• How much should be ordered?
Reasons for inventory
Economies of scale
Uncertainty
Speculation and changing costs over time
Smoothing and Logistics related reasons
Transportation
Costs of maintaining control system
Types of inventory
1. Raw materials
2. Components
3. Work-in-process
4. Finished goods
CHARACTERISTICS OF INVENTORY
SYSTEMS
Demand
o May Be Known or Uncertain
o May be Changing or Constant in Time

Lead Times -time that elapses from placement of order until it’s arrival.
can be known or unknown.
Review Time -Is system reviewed periodically or is system state known at
all times?
Treatment of Excess Demand
Inventory that changes over time --perishability, obsolescence
Costs in Inventory
1. Holding cost
2. Purchase Order or Production Order cost
3. Penalty or Shortage cost
Holding cost
• Cost of providing the
physical space to store the
items.
• Taxes and insurance.
• Breakage, spoilage,
deterioration, and
obsolescence.
• Opportunity cost of
alternative investment. Interest charges are always charged annually !
Cont.
Let c = euro value of one unit of
inventory
I= annual interest rate

h= Ic = holding cost in euros per

unit per year

Holding cost for Q units of

inventory per year = hQ Inventory as a function of time
Purchase Order or Production Order Costs
Costs proportional to the amount
of inventory that is ordered or
produced
Has two components - a fixed
and a variable component.
K =Fixed set up cost
-incurred independent of the size
of the order
c= unit order or production cost
Penalty Cost
All costs that accumulate when insufficient stock is available to meet
demand. These include:
–Loss of revenue for lost demand
–Costs of book keeping for backordered demands
–Loss of goodwill for being unable to satisfy demands when they occur.
–Generally assume cost is proportional to number of units of excess demand.
EOQ Inventory model
Economic Order Quantity (EOQ) model is
fundamental of all inventory models!
Some assumptions:
1. Demand is fixed at λ units per unit time.
2. Shortages are not allowed.
3. Orders are received instantaneously. (this will be
relaxed later).
4. Order quantity is fixed at Q per cycle. (can be
proven optimal.)
5. Cost structure:
a) Fixed and marginal order costs (K + cx)
b) Holding cost at h per unit held per unit time
EOQ Inventory model
• Order
   quantity replenished in one inventory
cycle=Annual demand consumed in one
inventory cycle of length T time units
Q=λT
Since Q decreases linearly, the average
inventory is Q/2
Holding cost = hQ/2
In each inventory cycle we have a fixed cost
and a proportional ordering cost
C(Q) = K + c Q
Order cost per unit time =C(Q)=
EOQ Inventory model
Average annual cost function G (Q)= Holding cost + Ordering cost
Convexity & Concavity
Convexity & Concavity
Convex function
•  Consider any function of a single variable that possesses a second
derivative at all possible values of
Concave function
•Consider
  any function of a single variable that possesses a second
derivative at all possible values of
EOQ Inventory model
Example
An East West Airlines company uses 60 tail lights per week. Each time
an order is placed, an ordering cost of Є12 is incurred. Each tail light
costs 2¢ . Holding costs are based on an annual interest rate of 25%.
Determine the optimum number of tail lights the company has to order
to keep total costs to minimum. Also determine the timing between the
placement of orders, yearly holding and setup costs.
Soln
Thank you