Inventory Model

Inventory Control
Inventory Control
 Inventory control is the technique of maintaining stock items at desired
levels.
 Excessive inventory levels are costly
 Insufficient inventory levels lead to stock outs
 The objective is to minimize the total inventory cost.
The basic inventory decisions include:

 How much to order?
 When to order?
 How much safety stock should be kept?
Costs of Inventory System
1. Purchase cost -- the actual price of the items
2. Ordering (or replenishment or set up) cost -- salaries and expenses of

processing an order, regardless of the order quantity
3. Holding (or Carrying) cost -- usually a percentage of the value of the

item assessed for keeping an item in inventory (including finance costs,
insurance, security costs, taxes, warehouse overhead, and other related
variable expenses)
4. Backorder(or Shortage or stock out) cost -- costs associated with

being out of stock when an item is demanded (including lost goodwill)
5. Other costs
Deterministic Models
• The simplest inventory models assume demand and the other

parameters of the problem to be deterministic and constant.
• The deterministic models covered in this chapter are:
– Purchase Model without shortages(EOQ with uniform demand)
– Manufacturing Model without shortages
– Purchase Model with shortages
– Manufacturing Model with shortages

Model-I- Economic Order Quantity(EOQ) model
with uniform demand
• EOQ is that size of the order for which the cost of maintaining inventories
is minimum. Therefore, the quantity to be ordered at a given time should be
determined by taking into account two factors,
-the acquisition cost and
-the cost of possessing materials.

Assumptions of the EOQ Model
1. Demand is known and constant
2. Lead time is known and constant
3. Receipt of inventory is instantaneous
4. Quantity discounts are not available
5. Variable costs are limited to: ordering cost and carrying (or holding) cost
6. If orders are placed at the right time, stock outs can be avoided
Inventory Level Over Time
Based on EOQ Assumptions
EOQ Model Total Cost
At optimal order quantity (Q*):

Carrying cost = Ordering cost
Economic Order Quantity(EOQ) model with
uniform demand
Variables:
Q* = Optimal order quantity (the EOQ)
D = Annual demand
Co = Ordering cost per order
Ch = Carrying (or holding) cost per unit per yr
P = Purchase cost per unit

Economic Order Quantity
Formulae
– Optimal order quantity: Q * = 2DCo/Ch
– Number of orders per year: D/Q *
– Time between orders (cycle time): Q */D years
– Total annual cost: [(1/2)Q *Ch] + [DCo/Q *]
(holding + ordering)
Example1
• Ram Industry needs 5400 units/year of a bought-out component which will
be used it its main product. The ordering cost is Rs 250 per order and the
carrying cost per unit year is Rs 30.Find the EOQ, the number of orders
per year and the time between successive orders

Solution
D = 5400 units/year
C0= Rs.250/order
Ch = Rs30/unit/year
Therefore, the economic order quantity
1. EOQ (Q*) = Q * = 2DCo/Ch
= 2 x 250 x 5400/30 = 300 units
2. Number of Orders/year = D/Q* = 5400/300 = 18
3. Time between successive orders(cycle time) = Q*/D = 300/5400

= 0.0556year
=0.6672 month
= 20days(approx)
Example 2
The annual demand of an item in the stores of a foundry is 9000 units. Its
annual carrying cost is 15% of the purchase price of the item per year, where
the purchase price is Rs 20 per unit. The ordering cost is Rs 15 per order.
Presently, the order size of the item is the average monthly demand of that
item. Find the economic order quantity and compare its cost with the present
ordering system and find the corresponding cost advantage if exists.
Solutions
• EOQ = 300 units

• Total cost = 1,80,900/year
• Present order size = 750 units
• Total cost of present order = 1,81,305/year
• Corresponding cost advantage is Rs 405/year
Example 3
The purchase manager currently follows EOQ policy of ordering for an item in
the stores of his company. The annual demand of the item is 1600 units. Its
carrying cost is 40% of the unit cost where the unit cost is Rs 400. The
ordering cost is Rs 500 per order. Recently, the vendor supplying that item
gives a discount of 10% in its unit cost if the order size is minimum of 500
units.
a) Find EOQ and the corresponding total cost per year
b) Check whether the discount offer given by the vendor can be considered
by the purchase manager
Solution
• EOQ = 100 units

• Total cost = 6,56,000/year
• Proposed ordering system
• Minimum order size(Q) = 500units
• P(after 10% discount) = (1-0.1) x 400 = 360
• Ch = 0.4 x 360 = Rs144/unit/year
• Total cost of proposed ordering system = Rs 6,13,600/ year
Model-2- Manufacturing Model without
shortages(EOQ with Production lot size)
r = Annual demand in units
k = Production rate of the item (total number of units produced/year)
C0 = Cost per set-up
Ch = Holding cost/unit/yr
P = Cost of produciton/unit
t1 =Period of production as well as consumption of the item
t2 =Period of consumption only
t = Cycle time
Manufacturing model without shortages
Formulae
– Economic Batch quantity(EBQ)= 2rCo/Ch[1-(r/k)]
– Period of production as well as consumption t1= Q */k
– Period of consumption only, t2= Q*/r(1-r/k)
– Cycle time t = t1 + t2
– Number of set-ups per year = r/Q*
–
Example1
• An automobile factory manufactures a particular type of gear within the

factory. This gear is used in the final assembly. The particulars of this gear
are : demand rate r = 14,000 units/year, production rate k = 35,000
units/year, set-up cost, Co= Rs 15/unit/year. Carrying cost is 0.45 Rs per
item per year
Solution
• EBQ = 1248 units (approx)
• The period of production as well as consumption = 13days
• The period of consumption = 20days
• Cycle time = 33days
• Number of setup per year = 11.22
Example2
A company manufactures a low cost bearing which is used in its main product
lin. The demand of the bearing is 10,000 units per month and the production
rate of the bearing is 25,000units per month. The carrying cost of the bearing is
Rs 0.02 per bearing per year and the setup cost is Rs 18 per setup. Find the
EBQ and the cycle time
Solution
• EBQ = 18,974 units (approx)
• Cycle time (EBQ/r) = 57days

Model-3-EOQ when shortages are allowed
The variables which are to be used in this model are

D= Demand/period
Co = Ordering cost / order
Ch = Carrying (or holding) cost/ unit/year
Cs = Shortage cost/unit/year
Q = Order size
Q1 = Maximum inventory
Q2 = Maximum stock-out
t1 = Period of positive stock
t2 =Period of shortage
t = Cycle time
Purchase model with shortages
Formulas
– Q * = [2CoD/Ch ][(Cs+ Ch )/Cs ]
– Q1 = [2CoD/Ch ][Cs / (Cs+ Ch )]
– Q2 = Q*-Q1
– t= Q */D
– t1= Q1 /D
– t2 =Q2/D
– Number of orders/period = D/Q*

Example 1
The annual demand for a component is 7200 units. The carrying cost is Rs
500/unit/year, the ordering cost is Rs 1500 per order and the shortage cost is
Rs 2000/unit/year. Find the optimal values of economic order quantity,
maximum inventory, maximum shortage quantity, cycle time(t), inventory
period(t1) and shortage period(t2)
Solution
Q* = 233 units
Maximum inventory (Q1) = 186 units
Maximum stock out (Q2) = 47 units
Cycle time (t) = 12 days
Period of positive stock t1 = 10days
Period of shortage t2 = 2days
Number of orders per year = 30.9
Example 2
The demand of a bought out item in a store is 12,000 units per year. The
carrying cost is Rs 2/unit/year and the ordering cost is Rs 600/order. The
shortage cost is Rs 10/unit/year. Find the EOQ and the corresponding number
of orders per year, the maximum inventory and maximum shortage quantity.
Solution
Q* = 2940 units
Maximum inventory (Q1) = 2450 units
Maximum stock out (Q2) = 490 units
Number of orders per year = 4.082 orders/year
Shortage quantity per year = 4.082 x 490 = 2000 units
Model-4- Manufacturing model with shortages
The variables which are used in this model are given below
r = Demand of an item/period
K = Production rate of the item (number of units produced/period)
Co = Ordering cost / order
Ch = Carrying (or holding) cost/ unit/year
Cs = Shortage cost/unit/year
t =Total cycle time
P = Cost of production/unit
t1 = period of production as well as consumptions of the item satisfying
period’s requirement
t2 = Period of consumption only
t3 = Period of shortage
t4 = Period of production as well as consumption of the item satisfying back
order
Manufacturing model with shortages
Formulas
– Q*= [2Co/Ch ] [kr/k-r] [Ch+ Cs / Cs ]
– Q1 = [2Co/Ch ] [r(k-r)/k] [Cs / Ch + Cs ]
– Q2 = [2CoCh/Cs(Ch +Cs)] [r(k-r)/k]
– t= Q */r
– t1= Q1 /k-r
– t2 =Q1/r
– t3 =Q2/r
– t4 =Q2/k-r
Example 1
The demand for an item is 6000units per year. Its production rate is 1000 units
per month. The carrying cost is Rs 50/unit/year and the set-up cost is Rs 2000
per set-up. The shortage cost is Rs 1000 per unit per year. Find the various
parameters of the inventory system
Solution
EBQ (Q*) = 1004 units

Q2 = 24 units
Q1 = 478 units
t = 61 days
t1 = 29days
t2 = 29days
t3 = 1.5days
t4 = 1.5 days
Example 2
• In a two wheeler manufacturing company, pistons are being fed into the
main assembly line from a product line situated in the next bay. The annual
demand for the pistons is 8000 units and the annual produciton capacity of
the product line manufacturing the pistons is 12,000 units. The set-up cost
is Rs 125 per setup and the carrying cost is Rs 4 per piston per year. The
shortage cost is Rs 8 per piston per year. Find Q,Q1,Q2,t,t1,t2,t3, & t4
Solution
EBQ (Q*) = 1500 pistons

Q2 = 167 pistons
Q1 = 333 pistons
t = 68.4 days
t1 = 30.4days
t2 = 15.2days
t3 = 7.6days
t4 = 15.2days
Model-5 EOQ with Quantity Discount
• When an item is purchased in bulk, buyers are usually given discount in the
purchase price of the item. Let i be the percent of the purchase price
accounted for carrying cost/unit/period. The discount may be a step
function of purchase quantity as shown below

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Inventory Control

 Excessive inventory levels are costly

 Insufficient inventory levels lead to stock outs

 The objective is to minimize the total inventory cost.

The basic inventory decisions include:

2. Ordering (or replenishment or set up) cost -- salaries and expenses of

3. Holding (or Carrying) cost -- usually a percentage of the value of the

4. Backorder(or Shortage or stock out) cost -- costs associated with

• The simplest inventory models assume demand and the other

• The deterministic models covered in this chapter are:

– Purchase Model without shortages(EOQ with uniform demand)

– Manufacturing Model without shortages

– Purchase Model with shortages

– Manufacturing Model with shortages

-the acquisition cost and

-the cost of possessing materials.

2. Lead time is known and constant

3. Receipt of inventory is instantaneous

4. Quantity discounts are not available

At optimal order quantity (Q*):

Q* = Optimal order quantity (the EOQ)

Co = Ordering cost per order

Ch = Carrying (or holding) cost per unit per yr

P = Purchase cost per unit

– Number of orders per year: D/Q *

– Time between orders (cycle time): Q */D years

– Total annual cost: [(1/2)Q *Ch] + [DCo/Q *]

per year and the time between successive orders

1. EOQ (Q*) = Q * = 2DCo/Ch

= 2 x 250 x 5400/30 = 300 units

2. Number of Orders/year = D/Q* = 5400/300 = 18

3. Time between successive orders(cycle time) = Q*/D = 300/5400

• EOQ = 300 units

a) Find EOQ and the corresponding total cost per year

• EOQ = 100 units

k = Production rate of the item (total number of units produced/year)

C0 = Cost per set-up

t1 =Period of production as well as consumption of the item

t2 =Period of consumption only

– Economic Batch quantity(EBQ)= 2rCo/Ch[1-(r/k)]

– Period of production as well as consumption t1= Q */k

– Period of consumption only, t2= Q*/r(1-r/k)

– Number of set-ups per year = r/Q*

• An automobile factory manufactures a particular type of gear within the

• Cycle time (EBQ/r) = 57days

The variables which are to be used in this model are

– Q1 = [2CoD/Ch ][Cs / (Cs+ Ch )]

– Number of orders/period = D/Q*

– Q*= [2Co/Ch ] [kr/k-r] [Ch+ Cs / Cs ]

– Q1 = [2Co/Ch ] [r(k-r)/k] [Cs / Ch + Cs ]

– Q2 = [2CoCh/Cs(Ch +Cs)] [r(k-r)/k]

EBQ (Q*) = 1004 units

EBQ (Q*) = 1500 pistons

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– Total annual cost: [(1/2)Q Ch] + [DCo/Q ]

1. EOQ (Q) = Q = 2DCo/Ch