13 Inventory Management

Answers to Questions

13-1. In general, independent demand items are final or finished products that are not dependent upon internal
production activity; that is, the demand is usually external and beyond the direct control of the
organization. Alternatively, dependent demand is usually a component part or material used to produce a
final product. An example of independent demand for a pizza restaurant would be a final product such as a
pizza, whereas dependent demand would be any of the ingredients (cheese, tomato sauce, dough, etc.) and
perhaps complementary items such as drinks.
13-2. In a fixed-order-quantity system, an order is placed for the same constant amount whenever the inventory
on hand decreases to a certain level, whereas in a fixed-time-period system, an order is placed for a
variable amount after an established passage of time.
13-3. The customer service level is the ability to meet internal or external demand at a specified level of
efficiency. High quality service is often perceived as always being able to meet demand, which normally
requires high inventory levels and can be costly, or efficient management of the inventory system such that
demand is met most of the time.
13-4. An ABC system is a method for classifying inventory according to its dollar value. In general, about 5 to
15 percent of all inventory items will account for 70 to 80 percent of the total dollar value of inventory.
Each level of inventory requires different levels of inventory control. That is, the higher the value of
inventory, the higher the control. Such a system generally requires less record-keeping and focuses
managerial attention on the most important inventory items.
13-5. The two basic inventory decisions are how much to order and when to order items for inventory. In a
continuous order system, whenever inventory decreases to a specific level (referred to as the reorder
point), a new order is placed for a fixed amount. Alternatively, in a periodic inventory system, inventory
on hand is counted at specific time intervals and an order is placed for an amount that will bring inventory
back to a desired level.
13-6. The categories are ordering cost, carrying cost, and shortage costs. As the order size increases, ordering
costs and shortage costs decrease while carrying costs increase.
13-7. The optimal order quantity occurs when the ordering cost equals carrying cost; thus, the order quantity can
be determined by equating these two cost functions and solving for the optimal value.
13-8. Demand is known with certainty, shortages are not allowed, lead time for order receipts is constant, and
orders are received all at once. These assumptions are limiting to the extent that they eliminate all
uncertainty and potential variation in the model.
13-9. In a continuous inventory system, the reorder point is the inventory level at which a new order is placed,
and lead time is the time required to receive an order after it has been placed.
13-10. In a noninstantaneous receipt model, the order quantity is received gradually over time and the inventory
level is depleted at the same time it is being replenished, whereas in the basic EOQ model orders are
received all at once.
13-11. The total purchase price of all items demanded must be included in the model, since the differences in
prices for different order sizes must be reflected in the model.
13-12. Price has no real impact on the optimal order size; it is a constant value that would not alter the basic
shape of the EOQ total cost curve.
13-13. The noninstantaneous receipt EOQ model would approach the basic EOQ model with instantaneous
receipt.
13-14. The service level is the probability that the amount of inventory on hand during the lead time is sufficient
 to meet expected demand. The safety stock is the amount of inventory to keep on hand necessary to
achieve this probability.

Solutions to Problems

13-1.

a.

b.

c.

d.

13-2.

Case Q TC
a 120.1 $14,051.25
b 120.1 $17,173.74
c 132.8 $15,534.24
d 108.6 $15,534.24

13-3.

a.
 b.

c.

d.

13-4.

13-5.
 a.

b.

c.

d.

13-6.

a.

b.
 c. = 5.56 rund

d.

e.

13-7.

13-8.
13-9.

a.

b.

c.

13-10.
13-11.

13-12. Operates 360 days/year

12 converters

5 tons coal/day/converter
 a.

b.

c.

13-13.

a.

b.
 c.

d.

The number of operating days to receive the entire order is

13-14. a.

b.
 Select the new location.

13-15. a.

b.

No, the total inventory cost increases.

13-17.

a.

The truck should carry approximately 9 orders each time it makes deliveries.

b.
13-18.

a.

b.
13-19.

13-20.

Without discount:
 with discount of

Take discount for

13-21.

Order Size P

0–4,999 $8.00

$6.50

Without discount:

With discount:
 Select discount;

13-22.

Without discount:

With discount:

Take the discount,

13-23.
 Select

13-24.
 Select

13-25.
13-26.

13-27.
13-28.
13-29.

13-30.

which corresponds to a 90% service level.

13-31.
13-32.

L = 12

(20)(12) + 1.28(4)sqrt(12)

=257.87 gal

=17.87 gal.

For service level of 95%

=(1.65)(4)sqrt(12) = 22.86 gal.

13-33.

For a 95% service level,

The reorder point increases to 286.7 gal.

13-34.
13-35.

Decision would be based on inventory holding cost, desire for low inventory, importance of
reliable delivery, cost of the monitors from each source, etc.

13-36.

13-37.

13-38.
13-39.

% %
Unit Annual Annual Annual
Item Usage Cost Usage Value Usage Class
25 870 105 $91,350 15.97% 10.43% A
23 30 2,710 81,300 14.21 0.36 A
20 19 3,200 60,800 10.63 0.23 A
22 12 4,750 57,000 9.97 0.14 A
24 24 1,800 43,200 7.55 0.29 A
16 60 610 36,600 6.40 0.72 A
5 18 1,900 34,200 5.98 0.22 A
10 67 440 29,480 5.15 0.80 B
12 682 35 23,870 4.17 8.18 B
2 510 30 15,300 2.68 6.11 B
4 300 45 13,500 2.36 3.60 B
1 36 350 12,600 2.20 0.43 B
27 750 15 11,250 1.97 8.99 B
9 344 28 9,632 1.68 4.12 B
29 46 160 7,360 1.29 0.55 B
26 244 30 7,320 1.28 2.92 B
28 45 110 4,950 0.87 0.54 B
13 95 50 4,750 0.83 1.14 C
30 165 25 4,125 0.72 1.98 C
18 270 15 4,050 0.71 3.24 C
6 500 8 4,000 0.70 5.99 C
7 710 4 2,840 0.50 8.51 C
21 910 3 2,730 0.48 10.91 C
17 120 20 2,400 0.42 1.44 C
19 45 50 2,250 0.39 0.54 C
8 80 26 2,080 0.36 0.96 C
3 50 23 1,150 0.20 0.60 C
11 510 2 1,020 0.18 6.11 C
15 820 1 820 0.14 9.83 C
14 10 3 30 0.01 0.12 C
8,342 571,957 100.00% 100.00%

13-40.

Class Items Quantity $ Value % Value % Quantity

13-41.

13-42.

a.

b. = 6.977 pizzas

CASE SOLUTION 13.1: The A to Z Office

Supply Company
Optimal loan amount per loan:

Memo:

The 0.0225Q cost per loan is not included in the calculation of Q since it is paid on the entire dollar
amount of the loan regardless of loan size, and thus it is simply an annual cost, i.e.,

When cash balance gets down to $255,000 initiate another loan.

Quantity Discount Analysis:

If
Since Q is unaffected by points, and Q was $371,842; we know we must set for this
alternate option.

Since this option yields a lower TC of it should be accepted.

The objective of this case problem is to determine the reorder point with variable demand. The
first step is to complete the average demand and standard deviation from the data provided in the
problem. This is a good opportunity to allow students to use a statistical software package (if
they have access to one) to compute these statistics.

The first question is, if what level of service does this correspond to. Thus, we are seeking Z
as follows

This Z value corresponds to a normal probability value of 0.8508, thus, the service level is
approximately 85.1 percent. The desired service level is 99 percent The reorder point and
safety stock for this service level is determined as follows.

Ms. Jones could determine the order size with EOQ analysis by using the average demand, d, as D in
the EOQ formula. However, she would also need the ordering and carrying costs. It is likely that the
ordering cost is relatively high as compared to carrying cost since the hats are shipped from Jamaica
while it would probably not be very expensive to store hats (given their small size and weight).
CASE SOLUTION 13.3: Pharr Food Company

This problem requires the development of a forecast for product demand in year 4 (see chapter 11). A
seasonal forecast was developed, as follows.

Year Jan–March April–May June–Aug Sept Oct Nov-Dec Total

1 607 488 479 256 342 524 2696

2 651 487 660 263 370 537 2968

3 685 539 672 302 411 572 3181

Total 1943 1514 1811 821 1123 1633 8845

0.220

0.171

0.205

0.093

0.127

0.185

Linear trend line forecast:

754.21

587.68

702.97

318.68

435.91

633.88

Total 3433.33
Comparing monthly forecasts (with seasonal pattern) with order size, Q, using order frequency of 2
months:

Monthly Forecast Balance

792 January 251 541

February 251 289

528 March 251 566

April 294 272

528 May 294 506

June 234 272

528 July 234 565

August 234 331

528 September 318 541

October 436 105

528 November 317 316

December 317

Total 3433

Note that the “.5” order was added to the first month. The order size seems to be adequate
to offset seasonal patterns.

Ingredient orders:

Chocolate
Nuts

Filling
 Pharr Foods might experience quality problems with its large orders for ingredients that take
advantage of price discounts; ingredients may be in storage for long periods. Also, the demand forecast is
treated with certainty; if significant variation occurs it could create shortages and the need for safety
stocks. Lead times are considered negligible, which could also create problems along the supply chain if
they are significant in reality.