Problem 1: (20 points)
A retail store is reviewing its inventory policy and is considering the use of a
backorder system to manage demand more cost-effectively. The product in question
has a steady annual demand of 10,000 units. Each time the store places an order, it
incurs a setup cost of NT2,500, while the purchase cost per unit is NT1,000. In the
case of a stockout, the store is willing to allow backorders, with a backorder cost of
NT 1,000 per unit. An important factor in this decision is the opportunity cost of
capital, which is currently estimated at 24% annually. This cost reflects the financial
impact of tying up money in inventory, and it plays a critical role in determining the
optimal ordering policy. Your task is to evaluate this scenario and determine the
most cost-effective approach for managing inventory. Specifically, you are asked
to calculate the optimal order quantity, the reorder point, the maximum
inventory level, and the total cost under the given assumptions. In addition, you
should develop an Excel spreadsheet model of the Economic Order Quantity
(EOQ) with backorders. This model should allow for sensitivity analysis on the
opportunity cost. Use it to generate a graph that illustrates how the total cost
changes as the opportunity cost varies between 2% and 30% and the
backorder cost ranges from NT 100 to NT 1,000.
D = 10,000 units
S = NT2,500
C = NT1,000
B = NT1,000/unit
i = 24%
H = iC = 24% × 1,000 = 240
Optimal order quantity:
Q¿ =
√ 2 DS
H
×
√H +B
B
=
√
2 ×10,000 ×2,500
240
×
1,000√
240+ 1,000
=508.27
The reorder point:
¿ H 240
¿Q × =258.27 × =9 8.37
H +B 1,000+240
The maximum inventory level:
¿ B 1,000
¿Q × =508 .27 × =409.89
H +B 1,000+240
The total cost:
TC=2 ×
( QD ) × S=2× ( 10,000
¿
D
508.27 )
× 2,500=98,373.88
Excel spreadsheet model:
[Link]
1iWPvDTviacraaog1DSGkD3OzCiB8k6Ux/edit?
usp=drive_link&ouid=100721761600799026673&rtpof=true&sd=true
When opportunity cost increases from 2% to 30% total cost increases
because it makes holding cost increase Q* decrease
When backorder costs are high, businesses want to avoid shortages
keep more inventories storage costs and total costs increase.
Problem 2: (20 points)
The Watkins Chemical Co. produces a chemical compound that is used as a
lawn fertilizer. The compound can be produced at a rate of 12,000 pounds per day.
Demand for the compound is 0.8 million pounds per year. The fixed cost of setting
up a production run of the chemical is $1,350, and the variable cost of production is
$3.60 per pound. The company uses an annual interest rate of 25% to account for
the cost of capital, and the annual costs of storage and handling of the chemical
amount to 10% of the value. Assume that there are 5 working days per week and 48
working weeks per year. What is the optimal lot size, maximum inventory level,
and total cost?
Problem 3: Case Study: Sony Taiwan – Strategic Sourcing for the
PlayStation 5 Taipei, Taiwan – November 2025
Albert Lin, the procurement manager for Sony Taiwan, sat in a quiet
conference room overlooking the city skyline. A major budget meeting loomed just
days away, and he was finalizing projections for the company’s most high-profile
import — the PlayStation 5.
The PS5 remained in strong demand in Taiwan, where Sony held a
commanding share of the gaming console market. For the upcoming year, demand
was projected at 10,000 units, with stable growth expected into 2026. Each console
carried a sourcing cost of NT$10,000, and with retail prices hovering near
NT$20,000, margins remained healthy — as long as Sony managed its inventory
wisely.
Each order placed with Sony’s regional supply chain hub came with a fixed
order cost of NT$1,000. However, the more significant challenge came from capital
and opportunity costs. While Sony Taiwan could borrow at an annual interest rate
of 1.5%, its average investment return across other projects was closer to 22%. The
firm’s finance team had begun pressing Lin to consider ways to reduce capital tied
up in inventory — including the possibility of offering customers a backorder
option, potentially trading service level for liquidity.
The Strategic Challenge
Lin’s team needed to evaluate multiple sourcing strategies under
deterministic demand assumptions. The first step was to calculate the optimal order
quantity based on current costs and demand forecasts. Then, if Sony Taiwan
introduced a backorder discount of 5% for customers willing to wait — reducing the
burden of carrying inventory — how would the order quantity change?
He also needed to project key operational metrics under this scenario: the
reorder point, the maximum inventory level, and the total cost. Most importantly,
Lin had to quantify whether this shift would generate any net savings, and if so, by
what percentage.
In addition, you should develop an Excel spreadsheet model of the Economic
Order Quantity (EOQ) with all variations of EOQ. This model should allow for
sensitivity analysis on the opportunity cost. Use it to generate a graph that illustrates
how the total cost changes as the ordering and holding cost changes.
Decision Point
The stakes were high. A misstep in inventory policy could either tie up
millions in idle stock or alienate loyal customers with delivery delays. On the other
hand, optimizing capital use could free resources for new marketing campaigns,
retail expansion, or R&D in next-gen gaming technologies.
As Lin fine-tuned his EOQ models and sensitivity analyses, he knew the
numbers would lead him to the right decision. But whether that decision would sit
well with the executive team — and Sony's brand reputation — was another matter
entirely. Please provide the detail of the calculation to the strategy change.