Part I
a) SO will order from the American supplier if demand exceeds 1500 units. With for
Q 1500 the z-statistic is z = (1500 – 2100) / 1200 = -0.5. From the Std Norm Dist
Func Table we see that ( 0.50) 0.3085 , which is the probability demand is 1500
or fewer. The probability demand exceeds 1500 is 1 ( 0.50) 0.6915 , or about
69%.
b) The supplier’s expected demand equals SO’s expected lost sales with an order
quantity of 1500 parkas. From the Std Norm Loss Func Table, L ( 0.50) 0.6978 .
Expected lost sales is L ( z ) 1200 0.6978 = 837.4.
c) The overage cost is Co =10 – 0 = 10, because left over parkas must have been
purchased in the 1st order at a cost of $10 and they have no value at the end of the
season. The underage cost is Cu =15 – 10 = 5 because there is a $5 premium on units
ordered from the American vendor. The critical ratio is 5 / (10 + 5) = 0.3333. From
the Std Norm Dist Func Table we see that ( 0.44) 0.3300 and ( 0.43) 0.3336,
so choose z = -0.43. Convert to Q : Q = 2100 – 0.43 1200 = 1584.
d) First evaluate some performance measures. We already know that with Q = 1584 the
corresponding z is –0.43. From Std Norm Loss Func Table, L ( 0.43) 0.6503 .
Expected lost sales is then 1200 0.6503 = 780.4, i.e., that is the expected order
quantity to the American vendor. If the American vendor were not available, then
expected sales would be 2100 – 780.4 = 1319.6. Expected left over inventory is then
1584 – 1319.6 = 264.4. Now evaluate expected profit with the American vendor
option available. Expected revenue is 2100 22 = $46,200. The cost of the 1st order
is 1584 10 = $15,840. Salvage revenue from left over inventory is 264.4 0 = 0.
Finally, the cost of the 2nd order is 780.4 15 = $11,706. Thus, profit is 46200 –
15840 – 11706 = $18,654.
e) If SO only sources from the American supplier, then expected profit would be ($22 -
$15) 2100 = $14,700, because expected sales would be 2100 units and the gross
margin on each unit is $7 = $22 - $15.
IInd Part!
a) Asian Supplier’s gross margin is $10 0.25 = $2.5. 2237 units are produced, so total
profit is 2237 $2.5 = $5592.
b) Asian Supplier’s regular production cost is 0.75 $10 = $7.5. Asian Supplier’s
expensive production cost is 2 $7.5 = 15. Asian Supplier earns $2.5 on each of the
939 units in SO’s 1st order. Asian Supplier charges 1.2 $10 = $12 for units in the
2nd replenishment. SO’s expected 2nd order quantity is 1267, and Asian Supplier
“earns” $12 - $15 = -$3 on those units despite the premium charged of 20%. Hence,
Asian Supplier’s profit is $2.5 939 - $3 1267 = -$1454.23
c) Now Asian Supplier can produce more than 939 units. The overage cost is $7.5 – 3 =
$4.5. If a unit is not produced in the 1st production run but could be sold, Asian
Supplier “earns” -$3 on that unit. If the unit were produced in the 1st production run,
Asian Supplier earns $12 - $7.5 = $4.5. Hence, the underage cost is $4.5 – (-$3) =
$7.5. In other words, every unit produced in the 1st production run that SO eventually
orders saves Asian Supplier $7.5 in profit relative to producing that unit in the 2 nd
production run. The critical ratio is 7.5 / (7.5 + 4.5) = 0.625. Thus, Z = 0.3186.
Therefore, Q = 2100 + 0.3186 * 1200 = 2482. Because that quantity is greater than
SO’s initial order of 939, Asian Supplier should produce 2482 units in the 1 st
production run.
d) If Asian Supplier produces 2482, then its expected 2nd production run is 312 units:
L(0.3186) = 0.2597, L ( z ) 1200 0.2597 = 312. Expected left over inventory is
tricky to evaluate. Expected left over inventory with Q = 2482 is 694 units.
Expected left over inventory with Q = 939 is 106 units. Hence, if Asian Supplier
produces 2482 units and SO’s 1st order is 939 units, then among the 1543 units (2482-
939) Asian Supplier produces above SO’s order, Asian Supplier can expect to have
694 – 106 = 588 remaining at the end of the season. (To explain, suppose demand is
only 800 units. Then Asian Supplier has 588 units left over, not 2482-800 = 1682,
i.e., left over inventory is the amount that is left over if the order quantity is 2482
minus the amount that would be left over if the order quantity is 939. This is
probably not obvious, which is why this is a hard question.) Asian Supplier’s
revenue is then revenue from the 1st order $10 939 = $9,390 plus revenue from the
2nd order $12 1267 = $15,204 plus revenue from left over inventory $3 588 =
$1764, for total revenue of $26,358. Costs include the 1 st production run = 2482
$7.5 = $18,615 and 2nd production run costs = 312 $15 = $4,680. Expected profit is
then $26,358 - $18,615 - $4,680 = $3,063.