Spring 2022 Fikri Karaesmen

INDR 372 PS EXERCISES, May 13, 2022

1. Consider the EOQ model with planned backorders below.

Suppose, however, that the constraint S/Q = 0.8 is added to the model.
Derive the expression for the optimal value of Q.
Solution:
Total cost per cycle:    
1 0.8Q 1 0.2Q
K + cQ + h 0.8Q + b 0.2Q
|{z} |{z} 2 a 2 a
setup cost per cycle variable ordering cost per cycle | {z } | {z }
inventory holding cost per cycle backorder cost per cycle

Total cost per cycle

Average cost per unit time: C(Q) = Q/a

2 2
C(Q) = Ka
Q
+ ca + h 0.32Q
Q/a
/a
+ b 0.02Q
Q/a
/a

Ka
C(Q) = Q
+ ca + 0.32Qh + 0.02Qb

We note that C(Q) is convex in Q. Then,

dC(Q) −Ka
dQ
= Q2
+ 0.32h + 0.02b = 0
q
Q∗ = Ka
0.32h+0.02b

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2. Consider the Economic Order Quantity problem with planned lost
sales. In each cycle Q items are ordered but the order cycle time T
is a parameter and is selected such that (T > Q/λ). This means that
some sales will be lost at the end of each order cycle. Assume that the
demand rate is λ, the unit holding cost is h, the fixed ordering cost is
k, the variable ordering cost is c and the unit lost sales cost is p. Note
that the lost sales cost is per unit item and not per unit time.

ˆ Assume Q items are ordered, and the cycle time is T where λT >
Q. Write an expression for the average cost per unit time (as a
function of Q, T , and the cost parameters).
Solution: The EOQ model is as below:

Total cost per cycle:  

1 Q
K + cQ + h Q
|{z} |{z} 2 λ
setup cost per cycle variable ordering cost per cycle | {z }
inventory holding cost per cycle
+ pλ(T − Q/λ)
| {z }
penalty cost for lost sales per cycle
Total cost per cycle
Average cost per unit time: C(Q) = T

2 /(2λ)
C(Q) = K
T
+ cQ
T
+ hQ T
+ p(λ − Q/T )

cQ Q 2
K
C(Q) = T
+ T
+ h 2λT + p(λ − Q/T )

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3. Consider the standard EOQ problem (i.e. Q units are ordered whenever
the inventory reaches zero) with the following new concern. We own
storage space for only Imax quantity units. Whenever the inventory
level exceeds Imax , we have to rent additional space to store the excess
inventory. The holding cost rate for the rented space is h+ TL (and
h+ > h).

ˆ Find an expression for the average inventory cost for an order

quantity of Q (as a function of the other given parameters).
Solution: If Q ≤ Imax , EOQ model is as below:

In this case, average inventory cost per unit time is hQ/2.

If Q > Imax , EOQ model is as below:

In this case, inventory cost per cycle is

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 Inventory cost per cycle = h+ · 12 (Q−Imax ) Q−Iλmax +h· (Q/λ+(Q−I2max )/λ)Imax

(Q−Imax )2 (2Q−Imax )Imax

Inventory cost per cycle = h+ · 2λ
+h· 2λ

Inventory cost per cycle

Then, inventory cost per unit time is equal to Q/λ
:

(Q−Imax )2 (2Q−Imax )Imax

Inventory cost per unit time = h+ · 2Q
+h· 2Q

To sum up, inventory cost per unit time can be written as

hQ/2 if Q ≤ Imax
(

(Q−Imax )2 (2Q−Imax )Imax

h+ · 2Q
+h· 2Q
if Q > Imax

4. 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 the item?
(d) Determine the batch size if you assume that the production rate
was infinite.

Solution: This is an EOQ problem with finite production rate. Please

review the results from the lectures. Note that all time units must be
consistent and conversions may be necessary.

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5. Your business plan for the summer is to sell high quality, designer
pareos in Kilyos. You can buy each pareo for 10 TL when you order
now. You think you can sell the pareos for 50 TL each in July and
August and you estimate that at that price the total demand for pareos
will be a uniformly distributed continuous random variable in (0,100).
You think that after the end of August you can no longer sell the pareos
and plan to give unsold pareos to your friends.

(a) What is the optimal number of pareos to order to maximize the

expected profit?
(b) What is the expected profit if you order the optimal number of
pareos?
(c) What is the probability of a loss (i.e. negative profit) if you order
fifty pareos (Hint: under what condition of demand can you lose
money when you order fifty pareos)?
Solution: Handwritten solution in a separate document.