Operations Research Inventory control

Inventory control
Introduction:
An inventory may be defined as a stock of idle resources of any kind having an
economic value. These could be in the form of physical resources such as raw materials,
semi-finished goods used in the production process, finished products ready for delivery
to consumers: human resource such as un-used labor or financial resource such as
working capital, etc.
Types of inventories maintained by various organizations:
____________ ____________________________
System Inventories
____________ _____________________________
1. Factory Raw-materials, parts, semi-finished goods, finished
goods etc.
2. Bank Cash reserves tellers.
3. Hospital Number of beds, specialized personnel, stocks of
drugs, etc.
4. Air-line company Air craft seat miles per route, parts for engine
repairs, steward ness, mechanics etc.

For many organizations inventories represents the amounts of tied up capital

usually 25 to 60 % of total assets, depending upon the type of the organization and the
industry. In sufficient inventories hamper production and fail to generate adequate sales,
where as excessive inventories adversely affect the firm’s cash flow and liquidity
position. Moreover one can’t rely purely on intuitive methods of establishing optimum
order quantities and setting up optimum inventory level. Hence some one can set policies,
establish guidelines, for inventory levels and ensure that appropriate control systems are
functioning well.
While inventories must be held to facilitate production activities, it must be noted
that larger inventories do not necessarily lead to high volume of out-put; where as lack of
inventories might hamper production. Inventories cost money to acquire as well as hold
them. The cost of acquisition is reduced as larger quantities are purchased each time and
the decrease in inventories reduces the inventory carrying costs. Thus the problem is to
Operations Research Inventory control

balance between the advantage of having inventories (or loss that may be expected from
not having adequate inventories) and costs of inventories to minimize the total inventory
cost. Inventories should be adequate to achieve maximum production and sales. At the
same time it should not be so excessive as to restrict the ability of organization to earn
high rate of return. The problem of keeping inventory at the optimal lever is of two fold:
1. To forecast the demand precisely at various points of time, and
2. To take steps to keep inventory at an optimal level i.e. to fine more economical
methods for its management.
Classification of Inventory:
1. Based on specific purpose of holding:
a) Lot size Inventory: these are held for two reasons
i) The large discounts on large quantities or lots.
ii) The material is available in lots easily rather than exact amounts.
b) Fluctuation Inventory:
These inventories exist because of fluctuation in demand or supply. Buffer
or safety stocks are of this kind.
c) Anticipation Inventory:
These are built-up in advance for a big selling season, a promotion
program or a plant shut down period. E.g. production and stocking of
Diwali Crackers, coolers etc.
d) Transportation Inventory:
These also called transit or pipe line inventories arise due to transportation
of inventory items to distribution centers and customers from various
production centers. The amounts of transportation inventory depend on the
time consumed in transportation and the nature of demand.
e) De-coupling Inventory:
If various products stages operate successively, then the event of break
down of one or any disturbance at some stage can affect the entire system.
This kind of inter dependence is not only costly but also disruptive. To
reduce this interdependence these inventories are maintained.
Operations Research Inventory control

2. The most common way of inventories:

a) production Inventories:
Items which are used to make products, raw materials, and bought out
finished components and bought out semi finished components.
b) Maintenance, Repair and Operation Inventories:
Items, which do not form a part of final product but are, consumed
indirectly in the production process, like spare parts, consumable items
etc.
c) In-process Inventories:
Semi finished products at various stage of production.
d) Finished goods Inventories:
Completed products ready for dispatch.
e) Miscellaneous Inventories:
Which arise, out of the above four type of inventories such as, scrap,
surplus and obsolete items, which are to be disposed off.
The operating doctrine:
The inventory control system two basic decisions are to be taken which are usually
referred to as operating doctrine of inventory. These are
i. How much to order?
ii. When to order?
To answer these questions one should be aware of the costs involved and other factors
that influence these decisions.
Inventory costs:
i. Set up cost:
The cost associated with setting up of the machinery before starting the
production, and is independent of the quantity ordered for production.
ii. Ordering Cost:
This is a cost associated with ordering of raw material for production.
Advertisement, consumption of stationary and postage, telephone charges, rent for
space used by purchase department, traveling expenditure, etc., constitute the
ordering costs.
Operations Research Inventory control

iii) Purchase or Production Costs:

This is cost of purchasing or producing a unit of item. This is very important
when discounts are allowed.
iv) Carrying or Holding Costs:
The costs associated with the storage costs like rent, interest on the money
locked up, insurance of stored equipment, production, taxes, depreciation of
equipment etc.
v) Shortage or Stock Out Cost:
The penalty cost for running out of stock (i.e. when item can’t be supplied on
the customers demand). This cost includes the loss of potential profit through
sales of items and loss of good will, in terms of permanent loss of customers
and its associated lost profit in future sales.
vi) Salvage Cost or Selling Price:
When the demand for certain commodity is affected by quality stocked,
decision problem based on a profit maximization criterion includes the
revenue from selling.
Terminology used in Inventory:
1. Demand:
Demand is the number of units required per period and it may be deterministic of
probabilistic.
2. Lead-Time:
It is the time gap between placing of an order and its actual arrival in the inventory is
termed as lead time. The longer the lead time, the higher is the average inventory.
3. Order Cycle:
The time period between placements of two successive orders is referred to as reorder
cycle. The reorder may be placed on the basis of two types of inventory review
systems. i.e. P-System & Q- System.
4. Stock Replenishment:
Replenishment of stock may occur instantaneously (when purchased from out side) or
uniformly (when the product is manufactured in house).
Operations Research Inventory control

5. Time Horizon:
The time period over which the inventory level will be controlled is the horizon.
This may be finite or infinite depending upon the nature of the demand of the commodity.
6. Re-order Level:
The level between maximum and minimum stock, at which purchasing or
manufacturing activities must start for replenishment is called the reorder level.
7. Re-Order Quantity:
This is the quantity of replenishment order. In certain cases it is known as
Economic Order Quantity.
Objectives of inventory:
The main objective of inventory control is to minimize the overall invest (or
costs) or inventory carrying at lowest possible level and consistency in operating
requirements.
1) To minimize carrying cost of inventory.
2) To supply the finished product / raw material / sub assemblies / semi finished
goods etc to the users as per their requirements at right time and right price.
3) To minimize the inactive, surplus, waste, scrap, obsolete, spoilage materials.
4) To reduce the shortage costs.
5) To minimize the replacement costs.
6) To maximize production efficiency and distribution effectiveness.
7) To maximize the return on investment.

Factors affecting inventory:

1) Economic parameters such as purchase price, production cost, selling price,
procurement cost, carrying cost, shortage cost, operating and information
processing cost etc.
2) Demand.
3) Ordering cycle and its review (continuous / periodic).
4) Deliveries lead / lag time.
5) Time horizon.
6) Number of supply echelons.
Operations Research Inventory control

7) Number of stages of inventory.

8) Number of items.
9) Availability and conditions.
10) Government’s / company’s policy.
Concept of average inventory:
For developing the economic lot size inventory model, following assumptions must be
made regarding the purchase of the single item of inventory.
i. Demand for the item is at a constant rate and is known to decision maker.
ii. The lead time or the time required for acquiring an item is also known.
Let ‘q’ be the order size under the above assumptions, it can be shown in fig.

The average inventory is affected by the order quantity and the number of orders
per year. More over, each new order is received into inventory at exactly the time at
which the previous order is decreased, resulting in no stock outs.

Concept of EOQ:
The concept is that management is confronted with a set of opposing costs as the
lot size (q) increases; the carrying charges (c 1) will increase while the ordering costs (c3)
will decrease. On the other hand, as the lot size (q) decreases, the carrying cost (c 1) will
decrease but the ordering costs will increase. Thus EOQ is that size of order which
minimizes total annual cost of carrying inventory and cost of ordering under the assumed
conditions of certainty and that annual demand are known.
Operations Research Inventory control

Types of inventory models:

1. Simple EOQ model
2. EOQ model with stock outs allowed
3. Inventory models under risk
Functions of Inventory control:
1. Separate different operations from one another and make them independent, so
that each operation (starting from raw material to finished goods) can be
performed economically.
Ex: independent of raw material can be carried out independently of the finished
goods distribution and both of these operations can be made low cost operations.
Say by ordering raw material and distributing finished goods in one big lot, than
in small batch sizes. Besides economy, the men and machines also can be better
utilized if the operations are separated and carried out in various departments than
if coupled and tied at one place.
2. maintain smooth and efficient production flow
3. Purchase in desired quantities and thus nullify the effects of changes in prices or
supply.
4. Keeps a process continuously operating?
5. Create motivational effect. A person may be tempted to purchase more if
inventories are displayed in bulk.
Operations Research Inventory control

Variables in Inventory Problem

The variables used in any inventory model are of two types
a. controlled variables
b. uncontrolled variables
Operations Research Inventory control

Controlled variables:
1. How much quantity acquired.
This may be adjusted for each type of resources separately or for all items
collectively in one of the following ways
i. The quantity to be ordered should be q quantity units.
ii. The quantity to be ordered should be such as to raise the stock
level to S quantity units.
iii. The quantity to be ordered should be such as to raise the stock
level on hand and on order to z.
2. The frequency of timing of acquisition. How often or when to replenish
the inventory?
i. The amount in stock equal to or below ‘S’ quantity units or
ii. The amount in stock and the amount of order are equal to or below
z; or
iii. At every ‘t’ time units.
3. The completion stage of stocked items;
More finished the goods, lesser the delay in meeting the demands. But, on
the other hand higher will be the cost of holding them in stock. Lesser
finished the stock items, longer the time in meeting the demands,
consequently lesser the cost of holding in stock.
Un-controlled variables:
1. holding costs (C1), shortage or penalty costs (C2), set up cost (C3)
Static
, Deterministic
2. demand Dynamic
Stationary
Probabilistic

Non-stationary
3. Lead time
Operations Research Inventory control

4. Amount delivered
Types of inventory models:
1. simple EOQ model
2. EOQ model with stock outs allowed
3. inventory models under risk

Inventory control approaches:

1. P-system or fixed period system or periodic review system:

In this system the orders are placed at a predetermined fixed period irrespective of
the quantities in stock. However, the re-order is placed for the quantities that are less
to the fixed based on the estimated consumptions or past records.

Ex: 1. with an over head water tank, we can under stand the above systems easily.
Suppose you depend on the municipal water supply, which gives you water only in
the morning at 6 a.m. every day. Then you fill your tank at 6 a. m. every day
irrespective of the stock in the tank.
Ex: 2. A government employee who receives salary during the first week dumps all
the grocery (Inventory) on every first week of the month.

2. Q-system or fixed quantity system or Two-bin system:

In this system the re-order level is fixed and when ever this level is reached,
irrespective of time, the order will be placed for procurement. Here, the reorder
Operations Research Inventory control

periods of different cycles are different and inventory cycles also differ since the re-
ordering depends on “when” the quantities reach the pre-determined minimum level.

Ex: 1. if you have a bore well in your campus, you will fill the tank wherever a
minimum level is reached irrespective of period of consumption.
Ex: 2. a business man may not bring his household grocery at every certain period,
but brings whenever a minimum level is reached.

The petrol / diesel in the fuel tank of your scooter / bike or any vehicle has two bins,
called main bin and a reserve, you start your procurement action which is in support
of Q-system while you may check-up air in the tyres periodically which is in p-
system.

Limitations of EOQ:
1. Ordering to the nearest quantities or packing. Say, instead of ordering 11
dozens, the order may be one gross. This may not be economic.
2. Modifying an order to get a better freight rate. The saving in freight may be
more than compensation the extra holding cost.
3. Simplification of routine. Instead of 14 times a year, one may order once a
month.
4. in case of perishable, or bulky items with diminishing consumption or for
items whose market, price are likely to decline, it may be better ot order less
than theoretical order quantity.
Operations Research Inventory control

5. Seasonal supply factors, market conditions, availability of transport etc., may

indicate larger or smaller purchase quantities. In these situations, judgment
should be given more weight.
6. Liberal discounts or concessional freight rates may suggest larger quantities.
The pros and cons of such purchase should be weighted carefully before
taking the decision.
Symbols used:
C1= holding cost per quantity unit per unit time
C2= Shortage cost per quantity unit per unit time for the back-log case and per unit item
only for no-back-log case.
C3= Setup cost (ordering) cost per order.
R= Demand Rate
K= production Rate
D= Total demand or Annual demand
q = quantity already present in the beginning
L = lead Time

Deterministic model with uniform demand rate and infinite production rate:
The various assumptions for this model are
a) No shortages are permitted
b) Demand rate is uniform
c) Production rate is uniform
Operations Research Inventory control

The stock level at the beginning of the model is q=Rt. The stock level
decreases at uniform rate R as the time passes and when reaches to Zero at the end of
time t. immediately the order is placed and the stock level is raised to the level q since
the production rate is infinite. The cost involved here are
Objective: To determine an optimal order quantity such that the total inventory cost is
minimized.
1. Average Inventory:

(Maximum level + minimum level)= (q+0) =

2. Total Inventory carrying cost:

=Average No. of units in inventory cost of one unit inventory carrying cost
percentage

= qC1

3. Total annual ordering cost:

=Number of orders per year ordering cost per order

= ( )C 3

4. Total inventory cost:

= Total inventory carrying cost + total annual ordering cost

C (q) = qC1+ ( )C 3

C (q) should be minimum, when inventory carrying cost is equal to the annual ordering
cost.

qC1= ( )C 3 q (E.O.Q) =

C (q)min= +

=
5. Optimum interval of ordering (t*):
Operations Research Inventory control

E.O.Q= demand Rate Interval of ordering

q=R t

t= =

6. Optimum number of orders (N):

7. The number of days supply per optimum order (d):

Solved problems on economic lot size with uniform demand:

1. A manufacturing company uses certain part at a constant
rate of 4000 units per year. Each unit cost Rs.2/- and the company personnel
estimates that it costs Rs.50 to place an order, the carrying costs of inventory is
estimated to be 20% per year. Find the optimum size of each order and minimum
yearly cost.
Solution:

1. E.O.Q= =

E.O.Q =1000 units

2. Minimum cost (Cmin) = =

= Rs.400
2. A manufacturing firm purchases 9,000 parts of a machine
for its annual requirements, ordering one month usage at a time. Each part costs
Rs.20. The ordering cost per order is Rs.15 and the carrying charges are 15% of the
average inventory per year. You have been asked to suggest a more economical
purchasing policy for the company. What advice would you offer, and how much
would it save the company per year?

Solution:
Operations Research Inventory control

The given data:

R= 9000 parts/ year

C1= each part / year

C3 = Rs.15 / order

E.O.Q= =

= 300 parts.

t*= =

Cmin = =
If the company follows the policy of ordering every month, then the annual ordering cost
becomes
= 12

Lot size inventories each month q=

Average inventory = =

Carrying cost or storage cost= = 375

Total cost = 1,125+180= Rs.1305

Therefore the company purchases 300 parts at time intervals 12 days instead of ordering
750 parts each month. So there will be a net saving of Rs.1305-900=Rs.405 per year.

Economic lot size with finite rate of replenishment

The various assumptions for this model are
Operations Research Inventory control

a) No shortages are permitted

b) Demand rate is uniform
c) Production rate is finite

The maximum point Q = Time of production run (t1)

[Production rate (K)–consumption (R)

Q=

Where t1= optimum number of units produced per run / production rate

Average inventory =

Total inventory carrying costs = Average inventory carrying cost

Total inventory cost C (q) = + ( )C 3

C (q)min when = ( )C 3

q*=

t* =

Solved problems on economic lot size with finite rate of replenishment :

Operations Research Inventory control

1. A tyre producer makes 1,200 tyres per day and sells them at approximately half that
rate. Accounting figures show that the production setup cost is Rs.1000 and carrying
cost per unit is Rs. 5. If annual demand is 1,200,000 tyres, what is the optimal lot size
and how many productions runs be scheduled per year?
Solution:
The given data is:
Production rate: 1,200 tyres per day
Demand rate : 600 tyres per day
Annual demand: 1, 20,000 tyres
Holding cost (C1) = Rs 5
Ordering cost (C3) = Rs 1000.

i. Optimal lot size q* =

= 9,798 tyres (approx).

ii. optimal production runs (N) per year is

= runs / year (approx).

2. A company has a demand of 12,000 units / year for an item and can produce 2,000
such items per month. The cost of one set up is Rs.400 and the holding cost/
unit/month is Re. 0.15. Find the optimum lot size and the total cost per year,
assuming the cost of 1 unit as Rs.4. Also find the maximum inventory, manufacturing
time and total time.
Solution:
The given data is:
R= 12,000 units / year
K= 2000 units per year
C3= Rs.400/ setup
C1= Rs.0.15
Operations Research Inventory control

i. qo = =

ii. Total cost:=12,000

= 48,000+ =Rs.50,940 / year.

iii. Maximum Inventory Imax= =

iv. Manufacturing time t1= =

v. Total time t0=

3. The annual demand for a product is 1, 00,000 units. The rate of production is 2,
00,000 units per year. The set up cost per production run is Rs.500 and the variable
production cost of each item is Rs.10. The annual holding cost per unit is 20% of its
value. Find the optimum production lot size and length of the production run.
Answers: q*= 1000(approx)
tp= 0.05 years (approx
4. A contractor has to supply 10,000 paper cones per day to a textile unit. He finds that
when he starts a production run he can produce 25,000 paper cones per day. The cost
of holding a paper cone in stock for one year is 2 paise. And the setup cost of a
production run is Rs 18. How frequently should production run be made?
Answers: q*= 1, 04,447(approx)
tp= 4 days (approx)

EOQ with shortages:

Operations Research Inventory control

EOQ with uniform demand, scheduling time constant (purchasing model):

Let S=qp- Z = maximum shortage per order (Back order quantity)

Z= maximum inventory level
tp = scheduling time period which is constant
t1 = time during which stock is available

t2= time during which stock there is a shortage and back orders occur
tp = t1+ t2
The determination of order quantity qp and desired starting inventory Z completely
specifies the value of the re-order level and the cycle time t p. the total annual inventory
cost for this model is
Total cost (TC) = ordering cost (C3) + carrying cost (C1) + shortage cost (C2)
Ordering costs

= ( )C 3

Carrying cost depends upon the average inventory.

Average inventory =

Carrying cost / cycle = t 1 C1

From triangles AEB and AFC

Operations Research Inventory control

t1=

Carrying cost per cycle=

Since tp is the fraction of the total time period (which is assumed to be a year) that elapses
between two successive orders and N is the number of orders placed per order hence N
=1.
Thus the annual carrying cost becomes

Shortage cost:
= average number of units short time of shortage per cycle shortage cost per unit per
time period

From triangles BDC and AFC

Shortage cost =

Annual shortage cost

Operations Research Inventory control

The total inventory cost is the sum of the three costs as described earlier

Total cost = ( )C + 3 +

Note: since set up cost C 3 and period tp are constant, the average set up cost also

being constant will not be considered in the cost equation.

C (Z) = +

To obtain the optimum order level Z, we differentiate C (Z) w.r.t to Z and set the
derivative equal to Zero. Thus, we get

(C1+C2) Z= qp-C2

Z* =

Cmin = =

C (Z) =( )C +
3 +

C (Z) =

Multiplying this equation by 2Rt2 and simplifying we get

-(C1+C2) Z2+C2R2t2=2RC3
Operations Research Inventory control

t*=

qp*=Rt* =

Z*=

Re-order level = qp*- Z*

Cmin=

EOQ with uniform demand, scheduling time constant (Manufacturing model):

The optimum result for this model are

qp*=Rt* =

S0=

t*=

Z*=
Operations Research Inventory control

CMin=

Problems on EOQ with shortages

1. A manufacturing firm has to supply 3,000 units annually, to a customer who does
not have enough space for storing the material. There is a contract that if the
supplier fails to supply the material, a penalty of Rs.40 per unit per month will be
levied. The inventory holding cost amounts to Rs.20 per unit per month and the
setup cost is Rs.400 per run. Find the expected number of shortages at the end of
each scheduling period.
Solution:
The given data:
R=3,000/12 = 250 units / month
C2 = Rs.40/ unit/ month
C1= Rs.20/unit/month,
C3= Rs.400 / run

Imax= =

qp* = =

No. of shortages So= 123-82= 41 units.

2. The demand of a chemical is constant at the rate of 1, 00,000 Kg, per year. The
cost of ordering is Rs.500. The cost per Kg of the Chemical is Rs.2. The shortage
cost is Rs.5 per Kg per year if the chemical is not available for use. Find out the
optimal order quantity and the optimal number of back orders. The inventory
carrying cost is 30%.

Solution:
The given data is:
R= 1,00,000 Kg / year
C3= Rs.500 / order
Operations Research Inventory control

C1= Rs.2 / Kg
C2= Rs.5 / Kg/ year

q*= = Kg.

Imax=

Optimum No. of back orders= 13,663-12,199=1,464 Kg.

3. The demand for an item in a company is 18,000 units per year, and the company
can produce the item at a rate of 3,000 per month. The cost of one setup is Rs.500 and
the holding cost of one unit per month is 15 paise. The shortage cost of one unit is
Rs.20 per year. Determine the optimum manufacturing quantity and the number of
shortages. Also determine the manufacturing time and the time between setups.

Solution:

The given data is:

R=18,000 units / year =15,00 units / month
K= 3,000 units / month
C3= Rs.500 / setup
C1= Re.0.15 / unit /month
C2= Rs.20/ unit / year = Rs.1.67 / unit/ month.

qp*= =

Imax= =

No. of shortages = qo- Imax= 4,669-2,142=2,527 units

Manufacturing time=

Time between setups, to=

Operations Research Inventory control

The E.O.Q models with price discounts:

In the previous EOQ models, the price per unit of the item held in the inventory
was constant regardless of the amount ordered, i.e. this cost was independent of the order
size q. However, there are many situations in which the order size q should be influenced
by the fact that a lower per unit price may be offered (price discount) by the suppliers to
encourage large orders from their customers. In such cases it is desirable to ensure
whether the savings in purchase cost due to price-discounts for large orders combined
with a decrease in ordering costs are sufficient to balance the additional carrying costs
duet to increased average inventory.
Such discounts help (i) suppliers in moving more inventory forward in the
distribution channel and lowering carrying costs if buyers purchase in large quantities and
(ii) Buyers in trading-off lowered purchasing and ordering cost with higher carrying
costs.
Price discounts:
If the supplier is ordering a single discount then one approach is to compare the present
total inventory cost without discount with the total cost if the total cost is accepted . the
total cost per time period is the sum of total ordering cost, carrying cost and purchase cost
of inventory items, i.e.

TC=DC+

=DC+

the procedure for determining how much to order (q *) when discounts are allowed and
minimum total cost TC* depends upon successive evaluation of various values q. the
purchase inventory model with single discount may be expressed as follows:

Order quantity Unit price (Rs)

1 P1
P2
Where b is the quantity at and beyond which the quantity discount applies and P2<P1
Operations Research Inventory control

The procedure for obtaining an optimal purchase quantity may be summarized in the
following steps.
Step1:
Calculate the optimal order quantity (EOQ) for the lowest price (highest discount), i.e.

q2*(P2) = , and compare the value of q2* with the quantity b which is required to

avail the discount.

If q2* then place orders for quantities of size q 2* and obtain
discount otherwise go to step 2.
Step 2:
If q2* ,
we can’t place order at the reduced price P 2, then evaluate q1* for price P1 and
compare TC (q1*) and TC (b) may be determined as follows:

TC (q1*) = DP1+

= DP1+

TC (b) = DP2+

= DP2+
If TC (q1*)> TC (b), then place orders for quantities of size b to get the discount.

Problems on single discounts:

1. Find the optimal Economic order Quantity for the following
Annual demand = 3,600 units
Ordering cost =Rs.50
Cost of storage =20% of the unit cost
Operations Research Inventory control

Price break:
Quantity unit cost (Rs)
20
18
Solution:
Step1:
The highest discount available is Rs.18. Thus calculating q 2* corresponding to that
quantity, i.e.

q2*=

Since q2* is more than b (i.e. 316.23 > 100), there fore the optimum purchase quantity
is given by
q*= q2* = 316.23 units / order.
2. Soft drinks manufacturing company buys a large number of pallets every year
which it uses in the warehousing of its bottled products. A local vendor has
offered the following discount schedule for pallets:
Order quantity unit price (Rs)
Up to 699 10.00
700 above 9.25
The average yearly replacement is 2400 pallets. The carrying costs are 12% of the
average inventory and ordering cost per order Rs.100.

Solution:
Step 1:
The highest discount available is Rs.9.25.thus calculating q 2* corresponding to that
quantity, i.e.

q2*=

Since q2* < b (i.e. 657. 59< 700), q2* is not feasible.
Operations Research Inventory control

Step 2:

Calculate q1* =

TC (q1*) = TC (632.45) = DP1+

=2400

=Rs. 24758.94

TC (b) =TC (700) = DP2+

= 2400

=Rs.22931.35
Since TC (b) < TC (q1*) and hence the optimal order quantity is the price discount
quantity, i.e. 700 units.
Double discount:
Order quantity unit price (Rs)
P1
P2

b2 P3
Where b1 and b2, are the quantities which determine the price discount. The procedure for
determining optimum purchase quantity may be summarized in the following steps.

Step1:
Calculate the optimal order quantity for the lowest price (highest discount), i.e. q 3* and
compare it with b2
a) If q3* , then place order equal to this optimal quantity q3*
b) If q3* < b2, then go to step 2.

Step2:
Operations Research Inventory control

Calculate q2* and since q3* < b2, this implies q2* is also less than b2. thus either q2*< b1, or

b1
a) if q2* < b2 but , then proceed as in the case of single discount .i.e. compare
TC(q2*) and TC (b2) to determine the optimum purchase quantity.
b) If q2* < b2, and b1, then go to step 3.
Step 3:
Calculate q1* and compare TC (b1), TC (b2) and TC(q1*) to determine the purchase
quantity.

Problem:
Find the optimal order quantity for a product for which the price discounts are as follows:
Order quantity unit price (Rs)
10.00
9.25
750 8.75
The monthly demand for the product is 200 units, storage cost is 2% of unit cost and cost
of ordering is Rs.100.
Solution:
The highest discount available is Rs.8.75. Thus calculating q 3* corresponding to this
range as follows:

q3*=

Since < b2 (i.e. 478< 750) go to step 2 to determine q2*

Step 2:

q2* =

Again since q2*< b2 and b1 (i.e. 465<750 and 500) go to step 3 to calculate q 1* and
compare total inventory cost corresponding to q1*, b1and b2.

Step 3:
Operations Research Inventory control

q1*=

TC (q1*) = TC (447) = DP1+

= 200

=Rs.2,086.96

TC (b1) =TC (500) = DP2+

= 200

=Rs.1,936.25

TC (b2) =TC (750) = DP3+

= 200

=Rs.1, 842.29
The lowest total inventory cost is TC (b 2) = Rs.1, 842.29 and hence the optimal order
quantity is the price discount quantity of 750 units, i.e. q* =b2= 750 units.

Re-order level (or point):

Re-order level or point may be defined as the level of inventory at which an order for
replenishment quantity is placed with the suppliers for procuring additional inventory
level to EOQ. The calculation of re-order level is based on the two following
assumptions:
i) lead time is constant
ii) rate of demand is constant
Thus the re-order level (R) is calculated as follows:
Operations Research Inventory control

R= amount of inventory used during lead time in units

=D
Where D= rate of demand for inventory during lead time in units.
L= lead time
As the inventory level droops to a predetermined level, called re-order level, an order for
fixed quantity is placed. But in order to avoid stock out a minimum inventory level
known as safety stock (or buffer) B is maintained. In this case the re-order level is
determined as follows:
Re-order level= safety stock+ rate of demand lead time
=B+DL
Safety stock:
In order to absorb variability, especially in demand and lead time, the inventory
management depends upon safety stock. The greater the safety stock maintained less is
the risk of stock outs. However such an increase in safety stock raises the carrying cost.
Thus the objective of maintaining safety stock is to balance extra carrying cost resulting
from safety stock and the expected cost of shortage.
Safety stock= (Max. lead time- Normal lead time) demand rate during lead time
Maximum inventory = ROL +EOQ – consumption during lead time.
Furthermore the levels of safety stock depend on what extent an organization is
prepared to accept stock out risk (SOR). Since it is difficult to obtain an accurate estimate
for the shortage cost, therefore the management must specify reasonable service level, so
as to determine the safety stock necessary to keep the stock out risk within prescribed
limits.
The service level is the probability of not running out of stock on any stock cycle,
i.e., percent of order cycle in which all the demand can be supplied from stock.
Service level = 100%-stockout risk
The determination of the required safety stock to support a given service level
depends on the type of inventory control system, i.e., whether orders are placed at fixed
intervals or in fixed amounts.
Problems on Safety stock:
Operations Research Inventory control

1. Obtain (i) EOQ (ii) No. of orders, (iii) re-order level and (iv) safety stock for the
following inventory problem:
Annual demand = 36,000 units
Cost per unit = Re. 1
Ordering cost =Rs.25
Cost of capital = 15%
Store charge= 5%
Lead time = ½month
Safety stock= one month consumption
Solution:

i) q*= = units

ii) No. of orders=

iii) Safety stock= units

iv) Normal lead time consumption = normal lead time monthly

consumption

= units

Re-order level= safety stock + Normal lead time consumption

=3000+1500=4500 units

2. Following information in an inventory problem is available:

Annual demand =2400 units
Unit price =Rs.2.40
Ordering cost =Rs.4
Storage cost = Rs.2%per year
Interest rate = 10% per annum
Lead time = ½ month
Calculate (i) EOQ (ii) Re-order level and (iii) total annual inventory cost
Operations Research Inventory control

How much does the total annual cost vary if the unit price is changed to Re.5?
Solution:

(i) EOQ = = units

(ii) Re-order level = D units

(iii) Minimum variable inventory cost =

Cost of 2400 units = 2400 therefore
Total inventory cost =Rs.74+5,670=Rs.5, 744
(iv) When price of an item is changed to Rs.5. then

q*(EOQ) = 258

Minimum variable cost =74

Cost of 2400 units =2400 there fore

Total inventory cost = Rs.(107+12,000)=Rs.12,107
Hence the increase in cost = Rs. (12,107-5,744) =Rs.6, 363

3. The ABC trailer company uses 2400 wheels per year in the manufacture of trailers.
It takes approximately 30 days to receive a shipment once an order has been placed.
The company tries to keep a minimum safety stock equal to an average of 30 days
requirement.
The cost associated with placing a purchase order has been estimated at Rs.100. the
estimated storage cost of average annual inventory is 20%. The company pays a net
purchase price of Rs.50 per wheel. Determine
a) the optimal order quantity,
b) maximum inventory level
Operations Research Inventory control

c) minimum inventory level

d) Reorder level.
Solution:
The given data is:
D= 2400 wheels/year

C1 =

C3 = Rs.100 per order.

a) E.O.Q= = wheels

b) Maximum inventory level =Buffer stock + E.O.Q

= (30-0) wheels

c) Average inventory quantity:

= wheels

d) re- order point = Buffer stock + consumption rate lead time

= 197.26+ wheels

4. A company uses annually 24000 units of a raw material which costs Rs.1.25 per unit.
Placing each order costs Rs.22.5 and the carrying cost is 5.4% per year of the average
inventory. Find the economic order quantity, and the total inventory cost (including
the cost of raw material).
Should the company accept the offer made by the supplier of a discount of 5% on
the cost price on a single order of 24,000 units?
Suppose the company works for 300 days a year. If the procurement time is 12
days and safety stock is 400 units, find the re-order point, the maximum and
minimum and average inventory.
Solution:
Operations Research Inventory control

E.O.Q= = units

t*= year

Therefore the optimum lot size is 4000 units, after every 2 months. Total annual
inventory cost
= purchasing cost per year + min cost
= 1.25
Now in order to use the discount offer, if the company uses the size of 24,000 units, then
each item costs. Rs.0.95 and there fore, the fixed annual cost will be Rs.0.95

Since he can order only once in a year, the annual ordering cost will be Rs.22.50 and the

average inventory is

So the annual carrying cost =

Therefore associated annual cost =Rs.28,500+22.50+769.50=Rs.29,292
However we observe that the total cost is less than the total annual cost calculated above
at the time of adopting the economic lot size policy, the discount offer is certainly
profitable and so he will accept the offer.
Since the company works for 300 days a year, the demand for one day will be

units

So in this case t* = days

Since t* is greater than the lead time and safety stock is 400 units, the re-order level will
be
=safety stock + normal lead time consumption
= 400 +12 units

Average inventory = B + units

Maximum inventory = B + q* = 400+ 4000 = 4400 units

Minimum inventory = B+0= 400 units
Operations Research Inventory control

Previous questions papers

November 2002 set-I
1. a) What is an inventory? What are the various types of inventory carried by a
production organization? Explain them briefly?
b) XYZ co. has estimated that 300 components will be required for a product line during
the next year. It costs 20% to carry one component in inventories for one year. The cost
of placing the order works at Rs.40. if the cost per item is Rs.5. What is the optimum
order quantity, time between the order and the number of orders per year?
November 2002 set-II
1. a) What are the costs re involved in carrying inventory? Explain them in
detail?
b) A small firm producing automobile brake linings estimates the steel
requirements for the next years production at 6000Kg. the cost of carrying
steel in inventories works out to Rs.1 per Kg. per month. The cost of ordering
works out at Rs.100 per order. If the cost per Kg. of steel is Rs.100. Find out
the economic order quantity, the number of orders per year, and total cost
incurred by the firm for one year.

November 2002 set-III

1. a) Describe the basic characteristics of an inventory system?
b) a firm producing transistor radio’s has estimated that it will require 12000
transistors components for the next years production. The cost of carrying
inventory is estimated at 25% of the value of the inventory per year. There are
two sources of supply: German firm and a Japan’s firm. The cost, insurance,
and freight (CIF) price per component from German firm works out at Rs.12
and from Japanese firm Rs.10. The ordering cost works out at Rs.120per
order. Which is the best source to buy from Germany or Japan? In addition, if
order quantity were at least 6000 units the CIF price would be Rs.9 per item.
November 2003
3. a) List the various models of inventory management. Explain any one of them in
detail?
Operations Research Inventory control

b) A manufacturer has to supply 10000 bearings to an automobile manufacturer.

He finds that when he starts a production run, he can produce 25000 bearings per
day. The cost of holding bearing in stock for one year is 20 paise and setup cost is
Rs.180 per setup. How frequently should the production run be made to minimize
the setup cost and holding cost?
May 2004 set IV
1. a) Explain with suitable examples fixed order quantity and fixed interval system
of inventory management?
b) An engineering firm has determined from the analysis of past accounting and
production data that part number 607 has ordering cost of Rs.350 per order and it
costs Rs.22 per part. The inventory carrying cost is 15% of the cost of the item per
year. The firm currently purchased Rs.2, 20,000 worth of this part every year.
Determine the economic order quantity. What is the time between two orders?
What is optimum number of orders per year to minimize the cost of the firm?

May 2004 set I

1. a) What is inventory management? Briefly explain the major decisions concerning
inventory?
b) A motor manufacturing Co. purchases 18,000 items of certain motor part for its
annual requirements, ordering one-month usage at a time. Each spare costs Rs.20.
The ordering cost per order is Rs.15 and carrying charges are 15% of the unit item
cost per year. Make a more economical purchasing policy. What is the savings by
the new purchasing policy?
May 2004 set II
1. a) With the help of quantity-cost curve, explain the significance of EOQ. What
are the limitations in using EOQ formula?
b) A purchase manager places order for an item in lot of 500 numbers of
particular item. Inventory carrying costs are 40% of the units cost, which is Rs.50
Operations Research Inventory control

per item, the ordering cost is Rs.600 per order, and the annual demand for the
item is estimated at 1000 units. Find out the loss incurred by the company for not
following the sufficient inventory policy?
May 2004 set III
5. a) Explain in detail what constitutes ordering cost and carrying cost. With help of
graph, show how they behave with increase in order quantity?
b) a dealer supplies the following information with regards to a product is dealing
with:
Annual demand : 10,000 units
Ordering cost : Rs.10 per order
Inventory carrying cost: 20% of the unit value of the item
Price per unit : Rs.20.
Determine EOQ?
May 2003 set I
1. a) What is inventory? Explain its importance in an industrial under taking?
b) What are different types of inventories in industry?
c) Describe various functions of inventory control?

May 2003 set II

1. a) Explain clearly the various costs that are involved in inventory problem with
suitable examples. How they are interrelated?
b) What are the advantages and disadvantages of increased inventory?
c) Write a note on variables in inventory problem?
May 2003 set III
1. a) What is EOQ? Discuss step by step the development of EOQ formula?
b) The demand of an item is uniform at a rate of 35 units per month. The fixed
cost is Rs.25 each time a production run is made. The production cost is Rs.1 per
item, and the inventory carrying cost is 50 paise per item per month. If the
shortage cost is Rs.1.5 per item per month, determine how often to make a
production run and of what size should be?
May 2003 set IV
Operations Research Inventory control

1. a) Explain the terms lead time, replenishment and set up cost as applied to an
inventory model and give examples?
b) A company producing motors decide to make a particular item in batches. The
following data is available.
Cost of setting up machine and tools Rs.800.
Annual rate of depreciation, interest etc: 15%
Consumption of parts in assembly shop: 100/ month
Processing each item takes 8 hours on the machine.
Labor rate Rs.10 per day (assume 8 hrs in a day)
Material cost Rs.3/ kg
Weight of each item: 15 Kg.
Over head expenses on each part is allocated as 100% of the prime cost. Find out the
Economic batch size for machining and also the duration machine run assuming that
the machine loading factor is 80%.

Hint: Prime cost = direct material cost + direct labor cost + (variable) direct
expenses.
Factory cost = prime cost + factory over head
Factory over head:
d) production or manufacturing over head
e) administration over head
f) selling over head
g) R& D over head
Total cost = factory cost + selling over head + distribution over head + administration
over head
Selling price = total cost ± profit or loss
Operations Research Inventory control