Group Assignment for Quantitative

Analysis for Decisions Making

Chapter Eight: Inventory Models

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 Prepared by group of students

NO Full name ID NO
1 ASHENAFI BENTI AYANO MBPR/003/2013
2 FIKIRTE DESSIE TEMESGEN MBAR/554/2013
3 HAREGEWOYEN HAILE KEEFO MBAR/553/2013
4 WONDIMU ASEFA WOLDESENBET MBAR/715/2013
5 WOYENISHET WONDIMU GEDIBO MBAR/711/2013
6 EMEBRU HAILE BIRKINEH MBAR/573/2013

Submitted to Gage University Quantitative Analysis for

Decisions Making for Masters of Business Administration
Section 14

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Chapter Eight: Inventory Models 2
 Course Outline

Chapter Eight: Inventory Models

• 8.1. Purchasing model without shortage
• 8.2. Purchasing model with shortage
• 8.3. Manufacturing model without shortage
• 8.4. Manufacturing model with shortage

Chapter Eight: Inventory Models

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 Chapter Eight: Inventory Models
Outline
• Deterministic models
–The Economic Order Quantity (EOQ) model
–Sensitivity analysis
–A price-break Model
• Probabilistic Inventory models
–Single-period inventory models
–A fixed order quantity model
• A fixed time period model
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 Chapter Eight: Inventory Models
Inventory Model
• Inventory model is a mathematical model that
helps business in determining the optimum level of
inventories that should be maintained in a
production process, managing frequency of
ordering, deciding on quantity of goods or raw
materials to be stored, tracking flow of supply of
raw materials and goods to provide uninterrupted
service to customers without any delay in delivery .

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 Deterministic models
Deterministic model is a method based on
the assumption that all parameters and
variables associated with an inventory
stock are known and that there is no
uncertainty associated with demand and
replenishment of inventory stock.

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 The Economic Order Quantity (EOQ) model

.
The Economic Order Quantity (EOQ)
model the demand is assumed to be
fixed and completely pre-determined

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 Cont...

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 EOQ Cost Model

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 Some Important Characteristics of the EOQ
Cost Function
At EOQ, the annual holding cost is the same as
annual ordering cost.

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 EOQ WITH PRICE BREAKS

Assumptions
• Demand occurs at a constant rate of D items per year.
• Ordering Cost is $S per order.
• Holding Cost is $H = $Cl per item in inventory per year
(note holding cost is based on the cost of the item, C).
• Purchase Cost is $C1 per item if the quantity ordered is
between O and x1' $C2 if the order quantity is between
x1 and x2, etc.
• Delivery time (lead time) is constant.

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 PROBABILISTIC MODELS
• Outline
– Probabilistic inventory models
– Single- and multi- period models
– A single-period model with uniform
distribution of demand
– A single-period model with normal
distribution of demand

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 Probabilistic Inventory Models
The demand is not known. Demand characteristics such as
mean, standard deviation and the distribution of demand
may be known.
Stock out cost: The cost associated with a loss of sales
when demand cannot be met. For example, if an item is
purchased at $1.50 and sold at $3.00, the loss of profit is
$3.00-1.50 = $1.50 for each unit of demand not fulfilled.

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Single- and multi- period models
Single- and Multi- Period Models
• The classification applies to the probabilistic
demand case
• In a single-period model, the items unsold
at the end of the period is not carried over to
the next period. The unsold items, however,
may have some salvage values.

Chapter Eight: Inventory Models 14

Cont.….

In a multi-period model, all the items

unsold at the end of one period are
available in the next period.
In the single-period model and in some
of the multi­period models, there
remains only one question to answer:
how much to order.
Chapter Eight: Inventory Models 15
Trade-offs in a Single-Period Models

Chapter Eight: Inventory Models

16
 Trade-off
Given costs of
overestimating/underestimating demand and
the probabilities of various demand sizes how
many units will be ordered?
Consider an order quantity Q
Let P = probability of selling all the Q units =
probability (demand>Q)
Then, (1-P) = probability of not selling all the
Q units
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 We continue to increase the order size so
long as

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 Decision Rule:

 Order maximum quantity Q such that

Where P = probability (demand>Q)

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 Text Problem Demand for cookies:

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 Cont.…..
Selling price=$0.69, cost=$0.49, salvage value=$0.29
• Sample computation for order quantity= 2200:
• Expected number sold=1800(0.05) +2000(0.10)
+2200(0.85) =2160 Revenue from sold
items=2160(0.69) =$1490.4
• Revenue from unsold items= (2200-2160) (0.29)
=$11.6 Total revenue=1490.4+11.6=$1502
• Cost=2200(0.49) =$1078
• Profit=1502-1078=$424

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 Cont.….

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 MULTl-PERIOD MODELS

• Outline
–A fixed order quantity model
–A fixed time period model

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 A FIXED ORDER QUANTITY MODEL

• Purchase-order can be placed at any time

On-hand inventory count is known always
• Lead time for a high speed modem is two
weeks and it has the following sales history
in the last 25 weeks:

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 Will you order now if number of items on hand is:

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 Cont.…
The same quantity, Q is ordered when inventory
on hand reaches a reorder point, R

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Chapter Eight: Inventory Models 26
 Cont.…
• An order quantity of EOQ works well
• If demand is constant, reorder point is the same
as the demand during the lead time.
• If demand is uncertain, reorder point is usually
set above the expected demand during the lead
time
• Reorder point = Expected demand + Safety
stock

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 Cont.….

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 Cont.…

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A fixed time period model

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 … The MIS concept: Foundation
• The MIS is a product of a multi-disciplinary
approach to the business management.
• It is a product which needs to be kept under
– a constant review and modification to meet the
corporate needs of the information.
• It is prescribed product design for the organization.
• The MIS is for the people in the organization.
• The MIS model may be the same but it differs
greatly in the contents.
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 Cont.….

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 Purchasing model without shortage
• Purchasing model without shortage:- If a company
manufactures an item which is required for it main product,
then the corresponding model is called Purchasing model
without shortage .Here, the assumptions are the same as that
of the Model-I except that of the instantaneous replenishment.
We assume that each production run of length t consists of
two parts, say t1 and t2 such that
• i) The inventory is building up at a constant rate of (k-r) units
per unit of time during t1, k>r.
• ii) There is no replacement (or production) during time t2 and
the inventory is decreasing at the rate of r per unit of time.

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 The inventory situation can be graphed as given
below:

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 Cont..
Where
• r= annual demand in units per day
• D= annual demand/year
• k= production rate of item (total number of units
produced/year
• t1=Period of production as well as consumption of
the item
• t2= Period of consumption only
• t=cycle of time (i.e., t=t1+t2)
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 Purchase Model with shortages
Purchase Model with shortages. If shortages occur
then these can be classified in to the following two
categories:
• a) As soon as the desired units of a certain commodity
arrive in inventory, back orders are satisfied.
• b) Shortages are lost sales.
• We assume all the situation of Model-I except that
shortages are allowed. Let C2 be the shortage cost per
unit of time per quantity

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 Cont.….
The inventory situation can be graphed as given
below

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 Cont.….
• Here, the total period is one year and is divided into two
equal parts, say of interval t. Further this time interval t
is divided into two parts t1 and t2 such that t=t1+t2
• During the interval t1, the items are drawn from the
inventory as needed and inventory t2, orders for the
item are being accumulated but not filled.
• Then at the interval t an amount q is delivered.
The amount q has been divided into q1 and q2
such that q=q1+q2 where q1 denotes inventory
and q2 denotes unfilled demand.
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 Manufacturing model without shortages
• Manufacturing model without shortages
• In this model the following assumptions are made:
• (1)Demand is at a constant rate (D).
• (2)All cost coefficients (C1, C2, C3) are constants.
• (3) There is no shortage cost, or C4 = 0.
• (4)The replacement rate is finite and greater than t
he demand rate. This is also called replenishment r
ate or manufacturing rate, denoted by R

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 Cont.….
• Suppose we take into account a company which
manufactures an item which is required for its main
product, then the corresponding model of inventory
is termed as manufacturing model.
• In this model, shortages are not permitted. The rate
of consumption of the item is assumed to be
uniform throughout the year.
• The item is produced and consumed
simultaneously for a portion of cycle time.

Chapter Eight: Inventory Models

40
 Cont.…
• The operation of the manufacturing model without
shortages is shown in figure 1

Chapter Eight: Inventory Models 41

 Manufacturing model with Shortages
Manufacturing model with Shortages
• The assumptions in this model are the same as
in model 3 except that the shortages are also considered. This
model
is illustrated in the figure in power point presentation of the lect
ure, given on the next page.
• There are four components of inventory costs in this
model. They are
• (1)Item cost.
• (2)Set up or order cost.
• (3)Items holding cost.
• (4)Shortage cost.
Chapter Eight: Inventory Models 42
 Cont.…
• In a manufacturing model with shortages an item is
produced and consumed simultaneously for a portion
of cycle time.
• During the remaining cycle time, only the
consumption of the item only takes place.
• The cost of production per unit is the same irrespective
of the production lot.
• Stock out is permitted in this model and it is assumed
that the stock out units which will be produced at a
later date.( Ponnuru Ramalinga Karteek, Karri Jyoti )

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 Cont.….

The Economic batch quantity for this model can be given as:
EBQ = (√2co/Cc)*(kr)/k-r*(Cc)/Cs
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Thank u

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