Advanced Operations Analysis (BUSI4498)
Problem Session on Inventory Management
1. [EOQ] A large automobile repair shop installs about 1,250 mufflers per year, 18 percent of which are
for imported cars. All the imported-car mufflers are purchased from a single local supplier at a cost of
£18.50 each. The shop uses a holding cost based on a 25 percent annual interest rate. The setup cost for
placing an order is estimated to be £28.
a) Determine the optimal number of imported-car mufflers the shop should purchase each time an
order is placed, and the time between placements of orders.
b) If the replenishment lead time is six weeks, what is the reorder point based on the level of on-
hand inventory?
c) The current reorder policy is to buy imported-car mufflers only once a year. What are the
additional holding and setup costs incurred by this policy?
d) Now let us assume that backorders are allowed and the corresponding cost is one third of the
holding cost. What is the optimal order quantity and what is the fraction of demand that is
backordered?
2. [POQ] The Wod Chemical Company produces a chemical compound that is used as a lawn fertilizer.
The compound can be produced at a rate of 10,000 pounds per day. Annual demand for the compound
is 0.6 million pounds per year. The fixed cost of setting up for a production run of the chemical is
£1,500, and the variable cost of production is £3.50 per pound. The company uses an interest rate of 22
percent to account for the cost of capital, and the costs of storage and handling of the chemical amount
to 12 percent of the value. Assume that there are 250 working days in a year.
a) What is the optimal size of the production run for this particular compound?
b) What proportion of each production cycle consists of uptime and what proportion consists of
downtime?
c) What is the average annual cost of holding and setup attributed to this item? If the compound
sells for £3.90 per pound, what is the annual profit the company is realizing from this item?
d) Determine the optimal batch size that would result in if you assumed that the production rate
was infinite.
3. [EOQ with multiple items] A local machine shop buys hex nuts and molly screws from the same
supplier. The hex nuts cost 15 cents each and the molly screws cost 38 cents each. A setup cost of $100
is assumed for all the orders. This includes the cost of tracking and receiving the orders. Holding costs
are based on a 25% annual interest rate. The shop uses an average of 20,000 hex nuts and 14,000 molly
screws annually.
a) Determine the optimal size of the orders of hex nuts and molly screws, and the optimal time
between placements of orders of these two items.
b) If both items are ordered and received simultaneously, the setup cost of $100 applies to the
combined order. Compare the average annual cost of holding and setup if these items are
ordered separately; if they are both ordered when the hex nuts would normally be ordered; and
if they are both ordered when the molly screws would normally be ordered.
c) What is the optimal joint replenishment cycle length? What is the overall cost in this case?
Compare this cost with the cases from part b.
4. [POQ with multiple items] Tomlinson Furniture has a single lathe for turning the wood for various
furniture pieces, including bedposts, rounded table legs, and other items. Four forms are turned on the
lathe and produced in lots for inventory. To simplify scheduling, one lot of each type will be produced
in a cycle, which may include idle time. The four products and the relevant information concerning
them appears in the following table.
Monthly Setup Time Production Rate
Piece Unit Cost
Requirement (hours) (units/day)
J-55R 125 1.2 20 25
H-223 150 0.8 35 50
K-18R 50 2.2 12 25
Z-344 240 3.1 45 40
Worker time for setups is valued at $85 per hour, and holding costs are based on a 20 percent annual
interest charge. Assume 20 working days per month and 12 months per year and 12 working hours pay
day for your calculations.
a) Determine the optimal length of the rotation cycle.
b) What are the optimal lot sizes for each product?
c) What are the percentages of uptime and downtime for the lathe, assuming that it is not used for
any other purpose?
d) Draw a graph showing the change in the inventory level over a typical cycle for each product.
5. [All units discount] In the calculation of an optimal policy for an all-units discount schedule, you first
compute the EOQ values for each of the three order costs, and you obtain: 𝑄 (0) = 800, 𝑄 (1) = 875,
and 𝑄 (2) = 925. The all-units discount schedule has breakpoints at 750 and 900. Based on this
information only, can you determine what the optimal order quantity is? Explain your answer.
6. [All units + Incremental discount] A large producer of household products purchases a glyceride used
in one of its deodorant soaps from outside of the company. It uses the glyceride at a fairly steady rate
of 40 pounds per month, and the company uses a 23 percent annual interest rate to compute holding
costs. The chemical can be purchased from two suppliers, A and B. A offers the following all-units
discount schedule:
Order size Price per Pound
0 ≤ 𝑄 < 500 1.30
500 ≤ 𝑄 < 1000 1.20
1000 ≤ 𝑄 1.10
Whereas B offers the following incremental discount schedule: $1.25 per pound for all orders less
than or equal to 700 pounds, and $1.05 per pound for all incremental amounts over 700 pounds.
Assume that the cost of order processing for each case is $150. Which supplier should be used?
7. [Newsvendor] Billy’s Bakery bakes fresh bagels each morning. The daily demand for bagels is a
random variable with a distribution estimated from prior experience given by following table:
Number of Bagels Probability
Sold in One Day
0 .05
5 .10
10 .10
15 .20
20 .25
25 .15
30 .10
35 .05
The bagels cost Billy’s 8 cents to make, and they are sold for 35 cents each. Bagels unsold at the end
of the day are purchased by a nearby charity soup kitchen for 3 cents each.
a) Based on the given discrete distribution, how many bagels should Billy’s bake at the start of
each day? (Your answer should be a multiple of 5.)
b) If you were to approximate the discrete distribution with a normal distribution, would you
expect the resulting solution to be close to the answer that you obtained in part (a)? Why or
why not?
c) Determine the optimal number of bagels to bake each day using a normal approximation. (Hint:
You must compute the mean 𝜇 and the variance 𝜎 2 of the demand from the given discrete
distribution.)
8. [(R,Q) and (s,S)] An automotive warehouse stocks a variety of parts that are sold at neighborhood
stores. One particular part, a popular brand of oil filter, is purchased by the warehouse for £1.50 each.
It is estimated that the cost of order processing and receipt is £100 per order. The company uses an
inventory carrying charge based on a 28 percent annual interest rate. The monthly demand for the filter
follows a normal distribution with mean 280 and standard deviation 77. Order lead time is assumed to
be five months. Assume that if a filter is demanded when the warehouse is out of stock, then the demand
is back-ordered, and the cost assessed for each back-ordered demand is £12.80. Determine the following
quantities:
a) The optimal values of the order quantity and the reorder level.
b) The average annual cost of holding, setup, and stock-out associated with this item assuming
that an optimal policy is used.
c) Evaluate the cost of uncertainty for this process. That is, compare the average annual cost you
obtained in part (b) with the average annual cost that would be incurred if the lead time demand
had zero variance.
d) Using the (Q, R) solution you obtained, determine appropriate values of (s, S).
e) Suppose that the demands during the months of January to September were as following:
Month Demand Month Demand Month Demand
January 300 April 310 July 390
February 330 May 240 August 420
March 260 June 350 September 380
If the starting inventory in January was 2000, determine the number of units ordered in each of the
months from January to September using (s, S) policy.
9. [Centralization vs Decentralization] A warehouse is being replaced with 3 warehouses and the demand
will be distributed based on 20%, 30% and 50% of the original demand in these warehouses.
a) How does this impact the average inventory level?
b) If we assume that a slow moving item that its demand follows a Poisson distribution is
considered, for the same service level, how much more safety stock is needed?
10. [S-1, S] Boeing Renton Factory located in Washington, provides a particular part for Boeing 737
aircrafts. Annual demand for this part follows a Poisson distribution. The probability of having no
demand during lead time is approximately 5% and the probability of having 1 demand during lead time
is approximately 15%. What is the base stock level that guarantees 90% of type 1 service? What it the
base stock level that guarantees 95% of type 1 service?