UNIT VII

INVENTORY MANAGEMENT AND

CONTROL
NATURE AND IMPORTANCE OF INVENTORY, FUNCTIONS
AND OBJECTIVES REQUIREMENTS FOR EFFECTIVE
INVENTORY
MANAGEMENT, INVENTORY COSTS, INVENTORY
CLASSIFICATION SYSTEM, ABC ANALYSIS, EOQ
MODELS, ECONOMIC PRODUCTION QUANTITY MODEL
References:
1. Stevenson, W. J. (2008). Inventory Management. Operations
Management (11th ed., pp. 554-616). New Delhi: Tata McGraw-Hill.
2. Heizer, J., & Render, B. (2013). Managing Inventory. Operations
Management (9th ed., pp. 497-540). New Delhi: Pearson Education
Inc.
3. Slack, N., Brandon, J. A., & Johnston, R. (2013). Inventory
Management. Operations Management (7th ed., pp. 368-402). New
Delhi: Pearson Education Inc.
 Inventory Management
■ Inventory is a stock that a firm holds for different
purposes.
■ Inventory is created when the receipt of materials, parts
and finished goods exceeds their disbursement.
■ It is depleted when their disbursement exceeds their
receipts.
■ Raw materials, work in progress/semi finished goods, and
finished goods inventory are some types.
■ Inventory plays significant role in the success of an organization.
■ It directly affects cost and quality of products and services.
■ Most of the time, the price of the product is determined by the cost
of raw materials.
■ Out of total cost, 20 to 75 percent cost is related to material cost
based on nature and types of the product.
■ Type of material used determines investment, and cost for storage,
transportation, insurance, wastage etc.
■ An effective management ensures the availability of raw
material at right time, cost, quality, and place.
■ Inventory management is the process of managing materials, parts
components, and equipment .
■ It is a core operations management activity.
■ It deals with controlling and regulating the flow of materials in
relation to changes in variables like demand, prices, availability,
delivery schedules etc.
■ It is responsible to make plan, organize, and control activities
relating to materials, parts or components of the organization.
■ Inventory management refers to the grouping of management functions
supporting the complete cycle of material flow from purchase and
internal control of production material to the planning and control of
work in process to the warehousing, shipping and distribution of the
finished goods.
■ Inventory Management is a process of managing activities
relating to flow of materials into and through the organization.
■ The inventory models described in this chapter relate primarily to
what are referred to as independent-demand items, that is, items
that are ready to be sold or used rather than for dependent-
demand items, which are components of finished products, rather
than the finished products themselves.
■ For example, a computer would be an independent-demand item,
while the components that are used to assemble a computer would
be dependent-demand items.
■ The demand for those items would depend on how many of each
item is needed for a computer, as well as how many computers are
going to be made.
 Objectives/Importance/Functions of Inventory Management

■ To ensure continuity of production with regular

uninterrupted supply.
■ Provide economy in purchasing and minimizing waste
and for higher productivity.
■ To minimize storage and stock control costs.
■ To purchase items of best quality at the most competitive
price.
■ Finding and selecting the materials and components with
correct specification.
■ To protect against stock outs
■ To take advantage of order cycles or quantity discounts
■ To hedge against price increases
■ To minimize the operating cost as low as possible and
increasing profit as much as possible without making
compromise in quality.
■ Receiving and controlling material safely and in good
condition.
■ Identification of surplus stocks and taking appropriate
measures to reduce it.
 Types of Inventory
■ On the basis of possession by the firm, there
are five types of inventory;
1. Cycle Inventory
2. Pipeline Inventory
3. Anticipation Inventory
4. Decoupling or Work In Progress (WIP)
Inventory
5. Safety Stock/Buffer Inventory
1. Cycle Inventory
– The portion of the total inventory that varies directly with the lot size is
called cycle inventory. Determining in what quantity to order is a lot
size.
– Average cycle inventory=Q/2, where Q=Lot size
2. Pipeline inventory
– The inventory moving from point to point in the material flow system is
called pipeline inventory.
– Because pipeline inventory is a function of demand during lead time, the
primary level is to reduce the lead time in order to in order to reduce
inventory cost.
– Pipeline inventory consists of orders that have been placed but not yet
received.
– Pipeline inventory=t*L, where L=Lead time, t=Average daily demand
3. Anticipation Inventory
– Inventory use to observe uneven rates of demand or supply which business
often faces.
– Seasonal demand pattern end themselves to the anticipation inventory. For
example, air condition.
4. Decoupling or WIP Inventory
– The concept of decoupling inventory is to decouple or separate different
parts of production system.
– During sequential operations activity, in case of breakdown of one
operation can affect the entire system.
– Thus point of inventory with reasonable stock level are created between
adjacent stages so as to achieve certain degree of independence in each
operations activity known to be WIP inventory.
5. Safety Stock/Buffer Inventory
– Inventory Surplus that a company holds to protect against uncertainties in
demand, lead time and supplies.
 Requirements of effective inventory
management
To be effective, inventory management must have the following:
1. A system to keep track of the inventory on hand and on order.
2. A reliable forecast of demand that includes an indication of
possible forecast error.
3. Knowledge of lead times and lead time variability.
4. Reasonable estimates of inventory holding costs, ordering costs,
and shortage costs.
5. A classification system for inventory items.
 Inventory Costs
In general, there are three major costs of inventory as shown below.
1. Ordering Cost
– The cost incurred when a firm orders an inventory is called ordering cost. It
is cost of preparing the purchase order from the suppliers. It is also called
Setup cost.
Ordering Cost = A/Q*O, where, A=Annual Demand and
O=Ordering cost per order
2. Carrying Cost
– It is the cost of holding the inventory in the firm for different purposes.
Therefore, it is also called Holding cost.
Carrying Cost = Q/2*C, where, C=Carrying cost per unit
3. Total cost of inventory
– It is the summation of ordering cost and carrying cost.
 Inventory System Concepts
A. Multi Stage Inventory System
 System of inventory in which inventory of parts are stocked at
more than one point in the sequential production process is
known as multi stage production system.
B. Multi-echelon/Level Inventory System
 The inventory system in which products are stocked at various
levels – factory, warehouse, suppliers, customer etc. in the
distribution system is known as multi-echelon inventory
system.
Numerical
 Inventory Control Systems
1. Continuous Review System or Fixed Order Quantity
System or Q/R Model or EOQ Inventory System
2. Price Break or Discount Problem
3. Periodical Inventory System or Fixed Time Period
Models or P Model or Fixed Order Interval System
4. Inventory Classification (ABC analysis)
 How much to order: Economic Order
Quantity model
■ EOQ model is used to identify a fixed order size that will minimize the sum of the
annual costs of holding inventory and ordering inventory.
■ Inventory ordering and usage occur in cycles.
■ The optimal order quantity reflects a balance between carrying costs and ordering costs:
■ As order size varies, one type of cost will increase while the other decreases.
■ The basic model involves a number of assumptions as shown below:
Figure: Average Cycle Inventory
Figure: Re-order level (ROL)
Figure: Economic Order Quantity (EOQ)
1. Continuous Review System or Fixed Order Quantity System or
Q/R Model or EOQ Inventory System
■ A continuous Review System (Q system), tracks the
remaining inventory on an item, each time a withdrawal is
made to determine whether it is time to reorder.
■ In this system, first all the fixed order quantity i.e. EOQ and
reorder quantity (R or ROL) are to be calculated.
■ It is an “event triggered” system as this system initiates an
order in the event of reaching a specific reorder level.
■ To regulate Q system, two things namely EOQ (Economic
Order Quantity) and Re-order Level (ROL) should be
calculated.
2. Periodical Inventory System or Fixed Time Period Models or P
Model or Fixed Order Interval System
■ Inventory is reviewed at (prefixed) periodic intervals
irrespective of the levels to which inventory drops
■ an order is placed to bring up the inventory to the
maximum level.
■ It is an “time triggered” system as this system initiates an
order reaching the specific time interval.
■ To regulate P system, two things namely Order Period (P)
and Maximum Target Inventory Level (T) should be
calculated.
 Formulae specific to Q System
1. Economic/Optimal order Quantity (EOQ)=
where, A = Annual Demand, O = ordering cost per order, C = Carrying Cost per
unit
2. Total Ordering Cost = A/EOQ*O
3. Total Carrying Cost = EOQ/2*C
4. Total Inventory Cost = A/EOQ*O+EOQ/2*C or
5. Total Inventory Cost with safety stock= A/EOQ*O+EOQ/2*C+SS*C
6. Total Inventory Cost with Price= A/EOQ*O+EOQ/2*C+A*Price
7. Reorder Level (ROL)= Lt + Safety Stock(SS) – Goods in Transit(GIT)
where, L = Lead time, t = daily or weekly consumption or demand
8. Optimal No. of order (N)= A/EOQ
9. Time Between Order or Cycle Time or order cycle (TBO) = EOQ/A* No. of working days
per weeks or months in a year (365 days for ever running organization)
10. Average inventory size/Average cycle Inventory =Q/2 + SS
11. Pipeline inventory = Avg. Inventory* Lead time = t*L
12. Maximum Inventory Size = Q+SS
13. Average inventory Value = Average Inventory size * Price
14. If TBO>L, No Goods in transit (GIT) exist, else GIT exists and each GIT
equals to lot size Q, which is subtracted form ROL.
Number of GIT = L/TBO, e.g. 7/4 = 1.75, hence Number of GIT = 1,
i.e. GIT =Q*1
15. Safety Stock (SS)= ZσL = Zσt √L
where, Z = Z value in normal distribution table, depend on Cycle
Service Level (CSL)
σL = Standard deviation during lead time
σt = Standard deviation of daily or weekly demand
Formulae specific to P System

1. Safety Stock (SS)= ZσP+L = Zσt √(L+P)

2. Total cost of inventory = A/tP*O+tP/2*C+SS*C
3. Target Inventory Level (T) = t(P+L) +SS
4. Quantity to be ordered = T –IP where,
Inventory Position (IP) = OH + SR - BO
where, OH=On hand inventory, SR=Scheduled receipt or Open
order, BO=Back order
Note:
■ In absence of any assumption in question, we should use 52 weeks or 365 days
in a year.
■ Sometimes, A is given and you have calculate daily/weekly demand (t) and vice
versa.
■ Lot size and carrying cost have direct relation while ordering cost and lot size
have indirect relation.
■ Sometimes it is assumed that the order to be placed is in multiple of 100 or
1000 and so on. Hence, rounding off to the lot size Q or EOQ is essential.
■ Sometimes, SS is given equivalent to daily/weekly consumption. E.g. SS = 10
days daily or weekly consumption, i.e. SS=10*t
■ If company orders before the ROL, average inventory will increase, but if
company orders below ROL, company may face shortage of inventory.
■ Q system = Q is fixed, TBO varies, ROL exist
P system = Q varies, TBO fixed, T exist
Example: EOQ model
A local distributor for a national tire company expects to sell approximately 9,600 steel-
belted radial tires of a certain size and tread design next year. Annual carrying cost is $16
per tire, and ordering cost is $75. The distributor operates 288 days a year.
a. What is the EOQ?
b. How many times per year does the store reorder?
c. What is the length of an order cycle?
d. What is the total annual cost if the EOQ quantity is ordered?
Given: A = 9600 tires, C = $16 per tire, O = $75, Working days = 288 days
a. EOQ = √2AO/C =
b. No. of order per year = A/Q =
c. Order cycle or Time between order (TBO) = EOQ/A * 288 days =
d. Total cost = Ordering cost + Carrying Cost
= A/Q*O + Q/2*C
Example: EOQ
■ For a Museum, sales are 18 units per week and the supplier charges $60 per unit. The cost of placing an order with the
supplier is $45. Annual holding cost is 25% of the product value and the museum operates 52 weeks a year. Lead time
is 2 weeks. Management must use a 390 units lot size so that the new order could be placed least frequently.
1. What is the annual cost of the current policy of using 390 units lot size? Would a lot size of 486 units be better?
2. Calculate the EOQ and its total cost and compare with the above results. How frequently the orders be made if
the EOQ is used? Also calculate number of orders and ROL using EOQ.
Given:
Weekly consumption (t) = 18 units
Price per unit = $60
ordering cost (O) = $45
carrying cost (C) = 25% of $60 = $15
Lead time (L) = 2 weeks
Working weeks = 52 weeks
Annual Consumption (A) = t * 52 = 18*52 = 936 units
1. Using current policy,
Lot size (Q) = 390 units
We know, Total cost of inventory = A/Q*O + Q/2*C
= 936/390 *45 + 390/2 * 15
= $ 3033
Using 486 units,
Lot size (Q) = 486 units
Total cost of inventory = A/Q*O + Q/2*C
=936*45/486 + 486/2*15 = $ 3732
Decision: No the lot size of 486 units is not better than the previous policy of using 390 lot size because the
total cost of using 486 units is higher than that of 390 units.
2. EOQ = √2AO/C = √2*936*45/15 = 75 units
Total cost of inventory using EOQ = A/EOQ*O + EOQ/2*C
= 936*45/75 + 75/2*15 = $(562+562) = $ 1124
Decision: Since the cost remarkably reduced to $ 1124 from $3033, it is far better to order
EOQ quantity.

Again,
Order period or TBO using EOQ = EOQ/A* 52 weeks = 75/936*52 = 4.17 weeks
No. of orders = A/EOQ = 936/75 = 12.48 times
Re-order Level (ROL) = Lt + SS – GIT = 2*18 + 0 – 0 =36 units
■ In our previous question (related to Museum) , suppose that the average demand is 18 units per week with
the standard deviation of 5 units. Determine the safety stock and Re-order point if the management wants
a 90% cycle service level? What is the total cost of inventory using Q system.
Given:
S.d of weekly demand (σt) = 5 units
Cycle service Level (CSL) = 90%
Now,
Safety Stock (SS)= ZσL = Zσt √L (s.d. during lead time σL= σt √L )
= 1.28*5*√2 = 9.05 units ≈ 9 units
Re-order Point (ROL) = Lt+SS-GIT (No GIT since TBO > L)
= 2*18+9.05 + 0 = 45.05 units
Total cost of inventory in current policy = A/Q*O+Q/2*C+SS*C
= 936/390*45 + 390/2*15+ 9*15 = $3168
Total cost of inventory using EOQ = A/EOQ*O+EOQ/2*C+SS*C
= 936/75*45 + 75/2*15+ 9*15 = $1259.1
■ In our previous question (related to Museum) , suppose that the average demand is 18 units per week with
the standard deviation of 5 units. Determine the safety stock and Re-order point if the management wants
a 90% cycle service level? What is the total cost of inventory using Q system.
Given:
S.d of weekly demand (σt) = 5 units
Cycle service Level (CSL) = 90%
Now,
■ Again, lets return to the example of museum. Recall that demand for museum is normally distributed with a mean of 18 units/week
and standard deviation of weekly demand of 5 units . What is the equivalent P-system cost? Also calculate maximum target inventory
level. If we have on-hand inventory of 50 units at the end of the period, how much we have to order?
Solution:
EOQ = √2AO/C = √2*18*52*45/15 = 75 units
P = TBO = EOQ/A* 52 weeks = 75/936*52 = 4.17 weeks ≈ 4 weeks
Hence, we review museum’s inventory every 4 weeks.
Now,
[Protection Interval = P+L = 4+2 = 6 weeks
S.d. of demand over protection interval (σP+L) = σt√P+L = 5 √4+2 = 12 units] optional
Again,
Safety Stock = ZσP+L = Zσt √P+L = 1.28*5 √4+2 =15 units
Now, Total P-system Inventory cost = A/tP*O + tP/2*C + SS*C
= 936/(18*4)*45 + (18*4)/2*15 + 15*15 = $1350
Target Inventory Level (T) = t(P+L) +SS
= 18(4+2) + 15 = 123 units
Quantity to be ordered = T - IP =123 – 50 = 73 units (IP = OH+SR-BO)
Decision: Every 4 weeks, we should order the number of units needed to bring Inventory Position (IP) up-to the target inventory level of
123 units.
■ Again, lets return to the example of museum. Recall that demand for museum is normally distributed with a mean of
18 units/week and standard deviation of weekly demand of 5 units . What is the equivalent P-system cost? Also
calculate maximum target inventory level. If we have on-hand inventory of 50 units at the end of the period, how
much we have to order?
Solution:
EOQ = √2AO/C = √2*18*52*45/15 = 75 units
P = TBO = EOQ/A* 52 weeks = 75/936*52 = 4.17 weeks ≈ 4 weeks
Hence, we review museum’s inventory every 4 weeks.
# A regional warehouse operates 5 days per week, 52 weeks per year and has average daily demand of 100 units (t). The following data are
estimated:
Holding cost = $ 9.4/unit per year (C)
Ordering cost = $ 35 per order (O)
Lead Time = 3 days (L)
Standard Deviation of daily demand =30 drills (σt )
Cycle Service Level = 92 % (CSL)
Current on-hand inventory (OH) is 380 units, with no open orders or back order.
Annual consumption (A)= t*(5*52) =26000
1. What order quantity Q should be used? EOQ = √2AO/C =
2. What would be the average time between orders? TBO =EOQ/A*(5*52) =
3. How many number of orders should be placed? N = A/EOQ
4. Determine Safety Stock. What reorder point R should be used? SS= Z σt √L =
5. An inventory withdrawal of 10 bags was just made, is it time to re-order?
6. If the store is using a lot size of 1000 units, calculate its annual inventory cost? TCI= A/Q*O + Q/2*C + SS * C
7. What would be the annual cost saved by shifting from 1000 units to the EOQ? TC 1000-TCEOQ
Suppose P system is used otherwise data are the same;
8. Calculate the P that gives approximately the same number of orders per year as EOQ. P = TBO =EOQ/A*(5*52) = 4.4
9. What is the value of Target Inventory, T? T = t(L+P) +SS
10. Is it time to review the item. On-hand inventory is 40 units, there is a scheduled receipt (open order) of 440 units and no
back orders. How much should be re-ordered? (IP = OH+SR-BO)
4. Total P-system inventory cost = A/tP*O + tP/2*C + SS*C
# A regional warehouse operates 5 days per week, 52 weeks per year and has average daily demand of 100 units (t). The following data are estimated:
Holding cost = $ 9.4/unit per year (C)
Ordering cost = $ 35 per order (O)
Lead Time = 3 days (L)
Standard Deviation of daily demand =30 drills (σt )
Cycle Service Level = 92 % (CSL)
Current on-hand inventory (OH) is 380 units, with no open orders or back order.
Annual consumption (A)= t*(5*52) =26000
1. What order quantity Q should be used? EOQ = √2AO/C = √2*26000*35/9.4 = 440.01 units
2. What would be the average time between orders? TBO =EOQ/A*(5*52) = 4.4 days
3. How many number of orders should be placed? N = A/EOQ = 59.08 times
4. Determine Safety Stock. What reorder point R should be used? SS= Z σt √ L = 1.41*30 √3 = 73.26 units
R=tL +SS – GIT = 100 * 3 +73.26 – 0 (TBO>L) = 373.26 units = 373 units
5. An inventory withdrawal of 10 bags was just made, is it time to re-order? Yes,
6. If the store is using a lot size of 1000 units, calculate its annual inventory cost? TCI= A/Q*O + Q/2*C + SS * C
7. What would be the annual cost saved by shifting from 1000 units to the EOQ? TCI= A/EOQ*O + EOQ/2*C + SS * C
Suppose P system is used otherwise data are the same;
8. Calculate the P that gives approximately the same number of orders per year as EOQ. P = TBO =EOQ/A*(5*52) = 4 days
9. What is the value of Target Inventory, T? T = t(L+P) +SS = 100 (3+4) + 111.91 = 811.91 units SS = Z
σt √ (L+P) = 1.41*30*√3+4 = 111.91 units
10. It is time to review the item. On-hand inventory is 40 units, there is a scheduled receipt (open order) of 440 units and no back
orders. How much should be re-ordered? (IP = OH+SR-BO = 40+440-0= 480) Quantity to be ordered = T –IP = 812 -480 = 332
units
■ Daily demand for a certain product is normally distributed with a mean of
60 and standard deviation of 7. The source of the supply is reliable and
maintains a constant lead time of 6 days. The cost of placing the order is $
10 and annual holding cost are $ 0.5 per unit. There is no stock out costs and
unfulfilled orders are fulfilled as soon as the order arrives. Assume sales
occur over the entire 365 days of the year. Find the order quantity and order
point to satisfy 95 % of probability of not stocking out during the lead time.
# At Dot Com, a large retailor of popular books, demand is constant at 32000 books per year. The cost of placing an order to
replenish stock is $10 and annual cost of holding is $4 per book. Stock is received 5 working days after an order has been placed.
No back ordering is allowed. Assume 300 working days a year.
a. What is Dot Com’s optimal order quantity? 400 units
b. What is the optimal no. of orders per year? 80 times
c. What is the optimal interval between orders? 3.75 days
d. What is demand during lead time and re order point? 533.35 units and 133.33 units

# Use the following information regarding of a product inventory:

Daily Usage 100 units
Production Setup cost $50
Holding cost per unit 20% of price
Cost of component $5
Lead time 2 days
Annual operating days 250 days
You are required to find EOQ, TBO and ROL.
# Sarah wishes to establish a reorder point system to manage inventory of standard Muffler. Use the
following information to determine the best order and reorder point.

Annual Demand 3500 mufflers

Item cost Rs 6/ muffler
Annual holding cost 25 % of item value
Ordering cost Rs 50 per order
Standard deviation of demand per day 6 mufflers
Service probability 90%
Lead time 2 days
Working days 300 days/year
# Petromax Enterprises uses a continuous review inventory control system for one of its inventory items. The
firm operates 50 weeks in a year. The following information is available on the item;
Demand = 50000 units a year
Ordering Cost = $ 35 per order
Holding Cost = $ 2 per unit per year
Average Lead time = 3 weeks
Standard Deviation of weekly demand = 125 units.

1. What is the economic order quantity for this item? 1322.88 units
2. If Petromax wants to provide a 90% cycle service level, what should be the safety stock and re-
order point? TBO = 1.32 weeks, SS=277.13, GIT=2645.76, ROL=787.25 units
Suppose that the Periodic Review System is used, but otherwise the data are the same.
3. Calculate the P that gives approximately the same number of orders per year as EOQ. 1.32 times.
4. What is the value of target inventory level, T? SS= 332.553 T=4753.012
5. Also calculate total P system cost. $ 3684.99
#A manufacturer makes monthly shipments of electric drills to a retailor in average lot size of 300 drills. The
retailer’s average demand is 80 drills a week, and the lead time from the manufacturer is 2 weeks. If the
retailor is willing to increase its purchase quantity to 400 drills, the plant will guarantee a lead time of 1 week
only. The retailor must pay for the inventory from the moment the manufacturer makes a shipment. What is
the effect on its cycle and pipeline inventory? Would you suggest the retailor to accept the new proposal?
Provide your reasons.

Solution:
Existing Proposed
Q = 300 drills Q = 400 drills
t = 80 drills t = 80 drills
L = 2 weeks L = 1 weeks
Now, Now,
Avg. Cycle Inventory = Q/2=300/2=150 units Avg. Cycle Inventory = Q/2 = 400/2 = 200 units
Pipeline Inventory = tL = 80*2 = 160 units Pipeline Inventory = tL = 80*1 =80 units

Decision: The effect of the new proposal on cycle inventories is to increase them by 50 units. The reduction in
pipeline inventories, however, is 80 units. The proposal would reduce the total investment in cycle and
pipeline inventories. Also it is advantageous to have shorter lead time because the retailor only has to commit
to purchases 1 week in advance rather than 2.
# Mr. A buys pen form oxford company and sells them in the market. He anticipates annual sells of 40,000 pens for his
market. The Oxford company charges prices as mentioned in the table for different order size it receives from its customer.
Quantity Price
0-999 Rs 20
1000-1999 Rs 17.5
2000 or above Rs 15.5
The purchase order is Rs 10 per order and the storage cost 20% of price paid for the pen. What is the optimum number of
units Mr. A should order from the company?
# Mr. A buys pen form oxford company and sells them in the market. He anticipates annual sells of 40,000 pens for his market. The
Oxford company charges prices as mentioned in the table for different order size it receives from its customer.
Quantity Price
0-999 Rs 20
1000-1999 Rs 17.5
2000 or above Rs 15.5
The purchase order is Rs 10 per order and the storage cost 20% of price paid for the pen. What is the optimum number of units Mr. A
should order from the company?
Solution:
Given: A=40000 pens, O=Rs 10, C=20% of price
At price P1 = Rs 20, C1 = 20% of Rs 20 = Rs 4
EOQ1 = √2AO/C1 = √2*40000*10/4 = 447.41 units
This EOQ1 lies between the order size of 0-999, so it is feasible. Therefore EOQ1 = 447.41 units
At price P2 = Rs 17.5, C2 = 20% of 17.5 = Rs 3.5
EOQ2 = √2AO/C2 = √2*40000*10/3.5 = 478.09 units
This EOQ2 doesn’t lies between the order size of 1000-1999, so is it is infeasible. Therefore EOQ2 = 1000 units
At price P3 = Rs 15.5, C3 = 20% of Rs 15.5 = Rs 3.1
EOQ3 = √2AO/C3 = √2*40000*10/3.1 = 508 units
This EOQ3 doesn’t lies between the order size of 2000 or above, is it is infeasible. Therefore EOQ3 = 2000 units
Calculation of Total cost of Inventory including Price
At EOQ1, Total cost of inventory = A/EOQ1*O+EOQ1/2*C1+A*P1= 40000/447*10+447/2*4+40000*20 = Rs 801788.86
At EOQ2, Total cost of inventory = A/EOQ2*O+EOQ2/2*C2+A*P2= 40000/1000*10+1000/2*3.5+40000*17.5 = Rs 702150
At EOQ3, Total cost of inventory = A/EOQ3*O+EOQ3/2*C3+A*P3= 40000/2000*10+2000/2*3.1 + 40000*15.5 = Rs 623300
Since, TC of inventory including Price is minimum at order size 2000 pens. Required optimum quantity (EOQ) is 2000 units.
# Mr. A buys pen form oxford company and sells them in the market. He anticipates annual sells of 40,000 pens for his market. The
Oxford company charges prices as mentioned in the table for different order size it receives from its customer.
Quantity Price
0-999 Rs 20
1000-1999 Rs 17.5
2000 or above Rs 15.5
The purchase order is Rs 10 per order and the storage cost 20% of price paid for the pen. What is the optimum number of units Mr. A
should order from the company?
Solution:
Given: A=40000 pens, O=Rs 10, C=20% of price
At price P1 = Rs 20, C1 = 20% of Rs 20 = Rs 4
EOQ1 = √2AO/C1 = √2*40000*10/4 = 447.41 units
This EOQ1 lies between the order size of 0-999, so it is feasible. Therefore EOQ1 = 447.41 units

At price P2 = Rs 17.5, C2 = 20% of 17.5 = Rs 3.5

EOQ2 = √2AO/C2 = √2*40000*10/3.5 = 478.09 units
This EOQ2 doesn’t lies between the order size of 1000-1999, so is it is infeasible. Therefore EOQ2 = 1000 units

At price P3 = Rs 15.5, C3 = 20% of Rs 15.5 = Rs 3.1

EOQ3 = √2AO/C3 = √2*40000*10/3.1 = 508 units
This EOQ3 doesn’t lies between the order size of 2000 or above, is it is infeasible. Therefore EOQ3 = 2000 units

Calculation of Total cost of Inventory including Price

At EOQ1, Total cost of inventory = A/EOQ1*O+EOQ1/2*C1+A*P1= 40000/447*10+447/2*4+40000*20 = Rs 801788.86
At EOQ2, Total cost of inventory = A/EOQ2*O+EOQ2/2*C2+A*P2= 40000/1000*10+1000/2*3.5+40000*17.5 = Rs 702150
At EOQ3, Total cost of inventory = A/EOQ3*O+EOQ3/2*C3+A*P3= 40000/2000*10+2000/2*3.1 + 40000*15.5 = Rs 623300
Past Question: Aug 2019
# Avtek, a distributor of audio and video equipment, wants to reduce a large stock of television. It has offered a local chain of stores a
quantity discount pricing schedule, as follows:
Quantity Price
1-49 $ 1,400
50-89 $ 1100
90+ $ 900
The annual carrying cost for the stores for a TV is 20 percent, the ordering cost is $2,500, and annual demand for this particular model TV
is estimated to be 200 units. The chain wants to determine if it should take advantage of this discount or order the basic EOQ order size.

Solution:
Given: A=200 pens, O= $ 2500, C=20% of price
At price P1 = Rs 1400, C1 = 20% of Rs 1400 = $ 280
EOQ1 = √2AO/C1 = √2*200*2500/280 = 59.76 units
This EOQ1 doesn’t lie between the order size of 1-49, so it is not feasible. Therefore EOQ1 = 49 units
At price P2 = Rs 1100, C2 = 20% of 1100 = Rs 220
EOQ2 = √2AO/C2 = √2*200*2500/220= 67.41 units
This EOQ2 lies between the order size of 50-89, so is it is feasible. Therefore EOQ2 = 67.41 units
At price P3 = Rs 900, C3 = 20% of Rs 900 = Rs 180
EOQ3 = √2AO/C3 = √2*200*250/180 = 74.53 units
This EOQ3 doesn’t lies between the order size of 90 or above, so it is infeasible. Therefore EOQ3 = 90 units
Calculation of Total cost of Inventory including Price
At EOQ1, Total cost of inventory = A/EOQ1*O+EOQ1/2*C1+A*P1= 200/49*2500+49/2*280+200*1400 = $ 297064.08
At EOQ2, Total cost of inventory = A/EOQ2*O+EOQ2/2*C2+A*P2= 200/67*2500+67/2*220+200*1100 = $ 234832.68
At EOQ3, Total cost of inventory = A/EOQ3*O+EOQ3/2*C3+A*P3= 200/90*2500+90/2*180+200*900 = $193655.55
Past Question: PU 2020
Following discount offer is given for a product. Find the most economic lot size.
Cost per unit=Rs.5
Ordering cost per order=Rs.49
Carrying cost per year=20%
Annual demand=5000 units per year
Quantity Discount (%) Price after discount
Up-to 999 0 Rs 5
1000-2499 10 Rs 4.5
2500-4000 20 Rs 4.0
4000 or more 25 Rs 3.75
Find the most economical Lot size.

Solution:
Given: A=5000 pens, O= Rs 49, C=20% of price
At price P1 = Rs 5, C1 = 20% of Rs 5 = Rs 1
EOQ1 = √2AO/C1 = √2*5000*49/1 = 700 units
This EOQ1 lie between the order size of 0-999, so it is feasible. Therefore EOQ1 = 700 units
At price P2 = Rs 4.5, C2 = 20% of 4.5 = Rs 0.9
EOQ2 = √2AO/C2 = √2*5000*49/0.9= 737.86 units
This EOQ2 doesn’t lies between the order size of 1000-2499, so is it is not feasible. Therefore EOQ2 =
1000 units
Continue...
#Suraj electronics uses 4000 toggle switches a year. Switches are period as
follow; 1 to 499, 90 paisa each, 500 to 999, 85 paisa each and 1000 and more,
80 paisa each . it costs approximately Rs 30 to prepare an order and receive it ,
and carrying costs are 40 % of purchase price per unit on an annual basis .
Determine the optimal order quantity.
Past Question: Feb 2019
# Mohan is the purchasing manager for the headquarters of a large insurance company chain with a central inventory
operation. Shiva’s inventory item has a demand of 6,000 units per year. The cost of each unit is $100, and the inventory
carrying cost is $10 per unit per year. The average ordering cost is $30 per order. It takes about 5 days for an order to
arrive, and demand for 1 week is 120 units. (This is a corporate operation, and there 250 workings days per year).
a. What is the EOQ? (2)
b. What is the average inventory if EOQ is used?(3)
c. What is the optimal number of orders per year?(3)
d. What is the optimal number of days in between any two orders? (3)
e. What is the annual cost of ordering and holding inventory?(3)
f. What is the total annual inventory cost, including cost of the 6,000 units?(3)
g. Calculate the reorder point? (3)

Given, A= 6000 units, O=$30, C= $10, L= 5 days, t= A/250 = 24 units, Price (P)= $100
a. EOQ= √2AO/C = √2*6000*30/10 = 189.75 units
b. Average Inventory Size = EOQ/2 =189.75/2 = 94.87 units
Average inventory value = Average Inventory Size * Price = 94.87*100 = $9486.83
c. No. of orders per year = A/EOQ = 6000/189.75 = 31.62 or 31 orders per year
d. Time Between Orders = EOQ*250/A = 189.75* 250 / 6000 = 7.9 or 7 days
e. Annual Cost = Ordering Cost + Holding Cost = A*O/EOQ +EOQ*C/2 = 6000*30/189.75 + 189.75*10/2 =
$1897.37
f. Total annual inventory including the cost of the 6,000 units =A*O/EOQ+EOQ*C/2+A*P= $601897.37
g. Reorder Point = Lt+ SS-GIT = 5*24 + 0 - 0 = 120 units [TBO>L]
Past Question: Feb 2020
# Nepal soft drink Company has a soft drink product which has a constant annual
demand rate of 3000 cases and cost Rs. 200/case. If ordering cost is Rs.20 and
inventory holding cost are charged at 25%, what is the EOQ for this product? Also
determine the cycle time (in days).
Past Question: Feb 2020
# A company currently has 200 units of a product on hand that it orders every two weeks
when the salesperson visits the premises. Demand for the product averages 20 units per day
with a standard deviation of 5 units. Lead time for the product to arrive is seven days.
Management has a goal of a 95 percent probability of not stocking out for this product. The
salesperson is due to come in late this afternoon when 180 units are left in stock (assuming
that 20 are sold today). How many units should be ordered?
2020 PU
■ A laboratory orders a number of chemicals from the same suppliers every 30 days. Lead
time is 5 days. The assistant manager of the lab must determine how of one of these
chemicals to order. A check of stock revealed that eleven 25ml jars are on hand. Daily
usage of the chemicals is approximately normal with a mean of 15.2 ml per day and a
standard deviation of 1.6 ml per day. The desired service level for this chemical is 95%.
Required:
How many jars of chemicals to be ordered?
What is the average amount of safety stock of the chemical?
Solution:
A = 4000 units
Price = $90
C =$9
O =$25
L = 5 days
Demand during lead time = L*t = 80 units
Now,
a. EOQ = √2AO/C = √2*4000*25/9 = 149.07 = 149 units
b. Average inventory Level = EOQ/2 + SS = 149/2+0 = 74.5 units
c. No. of order = A/EOQ = 4000/149 = 26.84 times
d. TBO = EOQ/A * 250 days = 149/4000*250 days = 9.31 days
e. TAIC = A/EOQ*O + EOQ/2*C +SS*C = 4000/149*25 + 149/2*9 + 0*9 = $1341.64
f. ROP = tL + SS – GIT = 80 + 0 – 0 = 80 ( TBO>L, so GIT doesn’t exist)
A distribution center (DC) experiences an average weekly demand of 50 units of one of
items. The product is valued at $650 per unit. Average inbound shipments from the factory
warehouse average 350 units. Average Lead time (including ordering delays and transit
time) is 2 weeks. The DC operates 52 weeks per year; it carries a 1 week supply of
inventory as safety stock and no anticipation inventory. What is the average aggregate
inventory being held by the DC.

Solution:
Type of Inventory Calculation of Average Inventory Quantity Total

Average Cycle Inventory Q/2 = 350/2 175 units

Safety Stock Inventory 1 week supply 50 units

Anticipation Inventory None 0 units

Pipeline Inventory tL = (50 units per week)(2 weeks) 100 units

Average Aggregate Inventory 325 units

Note: please refer to Types of Inventory for clarity.

■ A manufacturer makes monthly shipments of electric bulb to a retailor in average lot size of 300 drills.
The retailer’s average demand is 80 drills a week, and the lead time from the manufacturer is 2 weeks. If
the retailor is willing to increase its purchase quantity to 400 bulbs, the plant will guarantee a lead time of
1 week only. The retailor must pay for the inventory from the moment the manufacturer makes a
shipment. What is the effect on its cycle and pipeline inventory? Would you suggest the retailor to accept
the new proposal? Provide your reasons.

Solution:
Existing Proposed
Q = 300 drills Q = 400 drills
t = 80 drills t = 80 drills
L = 2 weeks L = 1 weeks
Now, Now,
Avg. Cycle Inventory = Q/2=300/2=150 units Avg. Cycle Inventory = Q/2 = 400/2 = 200 units
Pipeline Inventory = tL = 80*2 = 160 units Pipeline Inventory = tL = 80*1 =80 units

Decision: The effect of the new proposal on cycle inventories is to increase them by 35 units or 25%. The
reduction in pipeline inventories, however, is 70 units or 33%. The proposal would reduce the total investment
in cycle and pipeline inventories. Also it is advantageous to have shorter lead time because the retailor only
has to commit to purchases 1 week in advance rather than 2.
■ Nanglo Bread requires 20000 bags of wheat per year for the production of bread. Each
bag contains 50 k.g. wheat and purchase price is Rs 18. It costs 20 percent for holding
the inventory of wheat in stock per year and ordering costs per order is Rs 300. The firm
requires 5 days of lead time to receive the order placed and requires maintaining 10 days
of consumption in Safety Stock.
a. What is EOQ in kg?
b. What is the safety stock of wheat?
c. What is the total inventory cost of wheat including safety stock?
d. What is maximium inventory level of wheat?
e. What is average inventory level of wheat?
f. What is the re-order point?
g. If the supplier of wheat offers 0.2 % quanity discount for the order size of 20000 kg
of wheat, would you accept the offer?
Nanglo Bread Solution:
Given: A = 20000*50 = 1000000 kg, Price = Rs 18, C= 20% 0f 18 = Rs 3.6, O=Rs 300, L=5 days, SS= 10
days consumption
a. EOQ = √2AO/C = √2*1000000*300/3.6 = 12909.9 = 12910 kg
b. Safety Stock (SS)= 10 *t = 10 * 1000000/365 = 27397.3 kg
c. T. cost of wheat including SS = A/EOQ*O + EOQ/2*C + SS*C = 1000000/12910*300+ 12910/2*3.6+ 27397.3*
3.6 = Rs 145106.1
d. Maximum inventory level = Q + SS = EOQ + SS = 12910 + 27397.3 = 40307.3 kg
e. Average inventory level = Q/2 + SS = EOQ/2 + SS = 12910/2 + 27397.3 = 33852.3 kg
f. TBO = EOQ/A*365 = 12910/1000000*365 = 4.71
No. of GIT = L/TBO = 5/4.17 = 1.06 = 1, GIT = 1*Q =1*EOQ = 1* 12910 =12910 kg
ROP = tL + SS –GIT = 1000000/365*5 + 27397.3 – 12910 = 41095.93 -12910 = 28185.93 kg
g. Total cost of wheat including discount = A/Q*O + Q/2*C + SS*C – Discount
=1000000/20000*300 + 20000/2 * 3.5928 + 27397.3*3.5928 – A*P*Discount %
=1000000/20000*300 + 20000/2 * 3.5928 + 27397.3*3.5928 – 1000000*(18*0.2%)
= 15000 + 35928 + 98433.02 – 36000
= Rs 113361.02
WN: Price after discount = 18-0.2%of 18 = 18 – 0.036 = Rs 17.964
 Inventory Classification system
(ABC Analysis)

■ An important aspect of inventory management is that items held in

inventory are not of equal importance in terms of dollars invested,
profit potential, sales or usage volume, or stock out penalties.
■ For instance, a producer of electrical equipment might have electric
generators, coils of wire, and miscellaneous nuts and bolts among the
items carried in inventory.
■ It would be unrealistic to devote equal attention to each of these items.
■ Instead, a more reasonable approach would be to allocate control
efforts according to the relative importance of various items in
inventory.
■ The A-B-C approach classifies inventory items according to
some measure of importance, usually annual dollar value (i.e.,
dollar value per unit multiplied by annual usage rate), and then
allocates control efforts accordingly.
■ Typically, three classes of items are used: A (very important), B
(moderately important), and C (least important).
■ However, the actual number of categories may vary from
organization to organization, depending on the extent to which a
firm wants to differentiate control efforts.
■ With three classes of items, A items generally account for about
10 to 20 percent of the number of items in inventory but about 60
to 70 percent of the annual dollar value.
■ C items might account for about 50 to 60 percent of the number of
items but only about 10 to 15 percent of the dollar value of an
inventory.
■ These percentages vary from firm to firm, but in most instances
a relatively small number of items will account for a large share of
the value or cost associated with an inventory, and these items
should receive a relatively greater share of control efforts.
■ For instance, A items should receive close attention through
frequent reviews of amounts on hand and withdrawals.
■ The C items should receive only loose control, and the B items
should have controls that lie between the two extremes.
 Steps to A-B-C problem
Step 1: For each item, multiply annual volume by unit price
to get the annual dollar value.
Step 2: Arrange annual dollar values in descending order.
Step 3: The few (10 to 20 percent) with the highest annual
dollar value are A items. Those in between (about
20 to 30 percent) are B items. The most (about 0 60
to 70 percent) with the lowest annual dollar value
are C items.
Example: ABC Classification
A manager has obtained a list of unit costs and estimated annual demands for 10 inventory
items. Categorize the items on an A-B-C basis.
Solution:
Multiplying each item’s annual demand by its unit cost yields its annual dollar
value:
 Arranging the annual dollars values in descending order and assigning items to categories:

Decision: Category A has the fewest number of items but the highest percentage of annual dollar value,
while category C has the most items but only a small percentage of the annual dollar value.
Figure: ABC diagram
From the following details draw a plan of ABC selective control.
Item Unit Unit Cost
1 7000 5
2 24000 3
3 1500 10
4 600 22
5 38000 1.5
6 40000 0.5
7 60000 0.2
8 3000 3.5
9 300 8
10 29000 0.4
11 11500 7.1
12 4100 6.2
Solution:
Ite Unit Unit Usage Value Item Usage value % of % of Classification
m Cost (000) No. (Descending) Usage item
No. Value
1 7000 5 35 11 81.65 22.95 8.33
2 24000 3 72 A
2 72 20.23 8.33
3 1500 10 15 5 57 16.02 8.33
4 600 22 13.2 1 35 9.84 8.33
5 38000 1.5 57 B
12 25.42 7.17 8.33
6 40000 0.5 20 6 20 5.62 8.33
7 60000 0.2 12 3 15 4.21 8.33
8 3000 3.5 10.5 4 13.2 3.71 8.33
9 300 8 2.4 7 12 3.37 8.33
10 29000 0.4 11.6 C
10 11.6 3.26 8.33
11 11500 7.1 81.65 8 10.5 2.95 8.33
12 4100 6.2 25.42 9 2.4 0.67 8.33
355.77 100 100

Group A: 16.66 % of item and 43.18 % of value

Group B: 33.33 % of item and 38.64 % of value
Group C: 50 % of item and 18.18 % of value
Group A: 16.66 % of item and 43.18 % of value
Group B: 33.33 % of item and 38.64 % of value Figure: ABC diagram
Group C: 50 % of item and 18.18 % of value
Example: EOQ model
A local distributor for a national tire company expects to sell approximately 9,600 steel-belted radial tires of a
certain size and tread design next year. Annual carrying cost is $16 per tire, and ordering cost is $75. The
distributor operates 288 days a year.
a. What is the EOQ?
b. How many times per year does the store reorder?
c. What is the length of an order cycle?
d. What is the total annual cost if the EOQ quantity is ordered?
Given:
a. EOQ = √2AO/C
b. No. of order per year = A/Q
c. Order cycle or Time between order (TBO) = EOQ/A * 288 days
d. Total cost = Ordering cost + Carrying Cost
= A/Q*O + Q/2*C
Example: EOQ
■ For a Museum, sales are 18 units per week and the supplier charges $60 per
unit. The cost of placing an order with the supplier is $45. Annual holding
cost is 25% of the product value and the museum operates 52 weeks a year.
Lead time is 2 weeks. Management must use a 390 units lot size so that the
new order could be placed least frequently.
1. What is the annual cost of the current policy of using 390 units lot size?
Would a lot size of 486 units be better?
2. Calculate the EOQ and its total cost and compare with the above results.
How frequently the orders be made if the EOQ is used? Also calculate
number of orders and ROL using EOQ.
Given:
Weekly consumption (t) = 18 units
Price per unit = $60
ordering cost (O) = $45
carrying cost (C) = 25% of $60 = $15
Lead time (L) = 2 weeks
Working weeks = 52 weeks
Annual Consumption (A) = t * 52 = 18*52 = 936 units
1. Using current policy,
Lot size (Q) = 390 units
We know, Total cost of inventory = A/Q*O + Q/2*C
= 936/390 *45 + 390/2 * 15
= $ 3033
Using 486 units,
Lot size (Q) = 486 units
Total cost of inventory = A/Q*O + Q/2*C
=936*45/486 + 486/2*15 = $ 3732
Decision: No the lot size of 486 units is not better than the previous policy of using 390 lot size because the
total cost of using 486 units is higher than that of 390 units.
2. EOQ = √2AO/C = √2*18*52*45/15 = 75 units
Total cost of inventory using EOQ = A/EOQ*O + EOQ/2*C
= 936*45/75 + 75/2*15 = $(562+562) = $ 1124
Decision: Since the cost remarkably reduced to $ 1124 from $3033, it is far better to order EOQ quantity.
Again,
Order period or TBO using EOQ = EOQ/A* 52 weeks = 75/936*52 = 4.17 weeks
No. of orders = A/EOQ = 936/75 = 12.48 times
Re-order Level (ROL) = Lt + SS – GIT = 2*18 + 0 – 0 =36 units
■ In our previous question (related to Museum) , suppose that the average demand is 18 units per week with
the standard deviation of 5 units. Determine the safety stock and Re-order point if the management wants
a 90% cycle service level? What is the total cost of inventory using Q system.
Given:
S.d of weekly demand (σt) = 5 units
Cycle service Level (CSL) = 90%
Now,
Safety Stock (SS)= ZσL = Zσt √L (s.d. during lead time σL= σt √L )
= 1.28*5*√2 = 9.05 units ≈ 9 units
Re-order Point (ROL) = Lt+SS-GIT (No GIT since TBO > L)
= 2*18+9.05 + 0 = 45.05 units
Total cost of inventory in current policy = A/Q*O+Q/2*C+SS*C
= 936/390*45 + 390/2*15+ 9*15 = $3168
Total cost of inventory using EOQ = A/EOQ*O+EOQ/2*C+SS*C
= 936/75*45 + 75/2*15+ 9*15 = $1259.1
■ Again, lets return to the example of museum. Recall that demand for museum is normally distributed with a mean of 18 units/week
and standard deviation of weekly demand of 5 units . What is the equivalent P-system cost? Also calculate maximum target inventory
level. If we have on-hand inventory of 50 units at the end of the period, how much we have to order?
Solution:
EOQ = √2AO/C = √2*18*52*45/15 = 75 units
P = TBO = EOQ/A* 52 weeks = 75/936*52 = 4.17 weeks ≈ 4 weeks
Hence, we review museum’s inventory every 4 weeks.
Now,
[Protection Interval = P+L = 4+2 = 6 weeks
S.d. of demand over protection interval (σP+L) = σt√P+L = 5 √6.17 = 12 units] optional
Again,
Safety Stock = ZσP+L = Zσt √P+L = 1.28*5 √4+2 =15 units
Now, Total P-system Inventory cost = A/tP*O + tP/2*C + SS*C
= 936/(18*4)*45 + (18*4)/2*15 + 15*15 = $1350
Target Inventory Level (T) = t(P+L) +SS
= 18(4+2) + 15 = 123 units
Quantity to be ordered = T - IP =123 – 50 = 73 units (IP = OH+SR-BO)
Decision: Every 4 weeks, we should order the number of units needed to bring Inventory Position (IP) up-to the target inventory level of
123 units.
# A regional warehouse operates 5 days per week, 52 weeks per year and has average daily demand of 100 units. The
following data are estimated:
Holding cost = $ 9.4/unit per year
Ordering cost = $ 35 per order
Lead Time = 3 days
Standard Deviation of daily demand =30 drills
Cycle Service Level = 92 %
Current on-hand inventory is 380 units, with no open orders or back order.
1. What order quantity Q should be used?
2. What would be the average time between orders?
3. How many number of orders should be placed?
4. Determine Safety Stock. What reorder point R should be used?
5. An inventory withdrawal of 10 bags was just made, is it time to re-order?
6. If the store is using a lot size of 1000 units, calculate its annual inventory cost?
7. What would be the annual cost saved by shifting from 1000 units to the EOQ?
Suppose P system is used otherwise data are the same;
8. Calculate the P that gives approximately the same number of orders per year as EOQ.
9. What is the value of Target Inventory, T? 1000
10. It is time to review the item. On-hand inventory is 40 units, there is a scheduled receipt (open order) of 440
units and no back orders. How much should be re-ordered? (IP = OH+SR-BO = 40+440-0= 480)
■ Daily demand for a certain product is normally distributed with a mean of 60 and standard deviation of 7.
The source of the supply is reliable and maintains a constant lead time of 6 days. The cost of placing the
order is $ 10 and annual holding cost are $ 0.5 per unit. There is no stock out costs and unfulfilled orders
are fulfilled as soon as the order arrives. Assume sales occur over the entire 365 days of the year. Find the
order quantity and order point to satisfy 95 % of probability of not stocking out during the lead time.
# At Dot Com, a large retailor of popular books, demand is constant at 32000 books per year. The cost of placing an
order to replenish stock is $10 and annual cost of holding is $4 per book. Stock is received 5 working days after an
order has been placed. No back ordering is allowed. Assume 300 working days a year.
a. What is Dot Com’s optimal order quantity? 400 units
b. What is the optimal no. of orders per year? 80 times
c. What is the optimal interval between orders? 3.75 days
d. What is demand during lead time and re order point? 533.35 units and 133.33 units

# Use the following information regarding of a product inventory:

Daily Usage 100 units
Production Setup cost $50
Holding cost per unit 20% of price
Cost of component $5
Lead time 2 days
Annual operating days 250 days
You are required to find EOQ, TBO and ROL.
# Sarah wishes to establish a reorder point system to manage inventory of standard Muffler. Use the following
information to determine the best order and reorder point.

Annual Demand 3500 mufflers

Item cost Rs 6/ muffler
Annual holding cost 25 % of item value
Ordering cost Rs 50 per order
Standard deviation of demand per day 6 mufflers
Service probability 90%
Lead time 2 days
Working days 300/year
# Petromax Enterprises uses a continuous review inventory control system for one of its inventory items. The
firm operates 50 weeks in a year. The following information is available on the item;
Demand = 50000 units a year
Ordering Cost = $ 35 per order
Holding Cost = $ 2 per unit per year
Average Lead time = 3 weeks
Standard Deviation of weekly demand = 125 units.

1. What is the economic order quantity for this item? 1322.88 units
2. If Petromax wants to provide a 90% cycle service level, what should be the safety stock and re-
order point? TBO = 1.32 weeks, SS=433.012, GIT=2645.76, ROL=787.25 units

Suppose that the Periodic Review System is used, but otherwise the data are the same.
3. Calculate the P that gives approximately the same number of orders per year as EOQ. 1.32 times
4. What is the value of target inventory level, T? SS= 519.615 T=4753.012
5. Also calculate total P system cost. $ 3684.99
■ A manufacturer makes monthly shipments of electric drills to a retailor in average lot size of 300 drills.
The retailer’s average demand is 80 drills a week, and the lead time from the manufacturer is 2 weeks. If
the retailor is willing to increase its purchase quantity to 400 drills, the plant will guarantee a lead time of
1 week only. The retailor must pay for the inventory from the moment the manufacturer makes a
shipment. What is the effect on its cycle and pipeline inventory? Would you suggest the retailor to accept
the new proposal? Provide your reasons.

Solution:
Existing Proposed
Q = 300 drills Q = 400 drills
t = 80 drills t = 80 drills
L = 2 weeks L = 1 weeks
Now, Now,
Avg. Cycle Inventory = Q/2=300/2=150 units Avg. Cycle Inventory = Q/2 = 400/2 = 200 units
Pipeline Inventory = tL = 80*2 = 160 units Pipeline Inventory = tL = 80*1 =80 units

Decision: The effect of the new proposal on cycle inventories is to increase them by 50 units. The reduction in
pipeline inventories, however, is 80 units. The proposal would reduce the total investment in cycle and
pipeline inventories. Also it is advantageous to have shorter lead time because the retailor only has to commit
to purchases 1 week in advance rather than 2.
# Mr. A buys pen form oxford company and sells them in the market. He anticipates annual sells of 40,000 pens for his market. The
Oxford company charges prices as mentioned in the table for different order size it receives from its customer.
Quantity Price
0-999 Rs 20
1000-1999 Rs 17.5
2000 or above Rs 15.5
The purchase order is Rs 10 per order and the storage cost 20% of price paid for the pen. What is the optimum number of units Mr. A
should order from the company?
Solution:
Given: A=40000 pens, O=Rs 10, C=20% of price
At price P1 = Rs 20, C1 = 20% of Rs 20 = Rs 4
EOQ1 = √2AO/C1 = √2*40000*10/4 = 447.41 units
This EOQ1 lies between the order size of 0-999, so it is feasible. Therefore EOQ1 = 447.41 units
At price P2 = Rs 17.5, C2 = 20% of 17.5 = Rs 3.5
EOQ2 = √2AO/C2 = √2*40000*10/3.5 = 478.09 units
This EOQ2 doesn’t lies between the order size of 1000-1999, so is it is infeasible. Therefore EOQ2 = 1000 units
At price P3 = Rs 15.5, C3 = 20% of Rs 15.5 = Rs 3.1
EOQ3 = √2AO/C3 = √2*40000*10/3.1 = 508 units
This EOQ3 doesn’t lies between the order size of 2000 or above, is it is infeasible. Therefore EOQ3 = 2000 units
Calculation of Total cost of Inventory including Price
At EOQ1, Total cost of inventory = A/EOQ1*O+EOQ1/2*C1+A*P1= 40000/447*10+447/2*4+40000*20 = Rs 801788.86
At EOQ2, Total cost of inventory = A/EOQ2*O+EOQ2/2*C2+A*P2= 40000/1000*10+1000/2*3.5+40000*17.5 = Rs 702150
At EOQ3, Total cost of inventory = A/EOQ3*O+EOQ3/2*C3+A*P3= 40000/2000*10+2000/2*3.1 + 40000*15.5 = Rs 623300
Since, TC of inventory including Price is minimum at order size 2000 pens. Required optimum quantity (EOQ) is 2000 units.
Past Question: Feb 2019
# Mohan is the purchasing manager for the headquarters of a large insurance company chain with a central
inventory operation. Shiva’s inventory item has a demand of 6,000 units per year. The cost of each unit is
$100, and the inventory carrying cost is $10 per unit per year. The average ordering cost is $30 per order. It
takes about 5 days for an order to arrive, and demand for 1 week is 120 units. (This is a corporate operation,
and there 250 workings days per year).
a. What is the EOQ? (2)
b. What is the average inventory if EOQ is used?(3)
c. What is the optimal number of orders per year?(3)
d. What is the optimal number of days in between any two orders? (3)
e. What is the annual cost of ordering and holding inventory?(3)
f. What is the total annual inventory cost, including cost of the 6,000 units?(3)
g. Calculate the reorder point? (3)
Solution:
L = 5 days
TBO = 2 days
No. of GIT = L/TBO = 5/2 =2.5 = 2
GIT = 2*Q = 2*EOQ = 2 * 100 = 200 units
ROL =
Past Question: Aug 2019
# Avtek, a distributor of audio and video equipment, wants to reduce a large stock of television. It has offered a local chain of stores a
quantity discount pricing schedule, as follows:
Quantity Price
1-49 $ 1,400
50-89 $ 1100
90+ $ 900
The annual carrying cost for the stores for a TV is 20 percent, the ordering cost is $2,500, and annual demand for this particular model TV
is estimated to be 200 units. The chain wants to determine if it should take advantage of this discount or order the basic EOQ order size.

Solution:
Given: A=200 pens, O= $ 2500, C=20% of price
At price P1 = Rs 1400, C1 = 20% of Rs 1400 = $ 280
EOQ1 = √2AO/C1 = √2*200*2500/280 = 59.76 units
This EOQ1 doesn’t lie between the order size of 1-49, so it is not feasible. Therefore EOQ1 = 49 units
At price P2 = Rs 1100, C2 = 20% of 1100 = Rs 220
EOQ2 = √2AO/C2 = √2*200*2500/220= 67.41 units
This EOQ2 lies between the order size of 50-89, so is it is feasible. Therefore EOQ2 = 67.41 units
At price P3 = Rs 900, C3 = 20% of Rs 900 = Rs 180
EOQ3 = √2AO/C3 = √2*200*250/180 = 74.53 units
This EOQ3 doesn’t lies between the order size of 90 or above, so it is infeasible. Therefore EOQ3 = 90 units
Calculation of Total cost of Inventory including Price
At EOQ1, Total cost of inventory = A/EOQ1*O+EOQ1/2*C1+A*P1= 200/49*2500+49/2*280+200*1400 = $ 297064.08
At EOQ2, Total cost of inventory = A/EOQ2*O+EOQ2/2*C2+A*P2= 200/67*2500+67/2*220+200*1100 = $ 234832.68
At EOQ3, Total cost of inventory = A/EOQ3*O+EOQ3/2*C3+A*P3= 200/90*2500+90/2*180+200*900 = $193655.55
Past Question: PU 2020
Following discount offer is given for a product. Find the most economic lot size.
Cost per unit=Rs.5
Ordering cost per order=Rs.49
Carrying cost per year=20%
Annual demand=5000 units per year
Quantity Price
Up-to 999 $0
1000-2499 $ 10
2500-4000 $ 20
4000 or more $ 25
Past Question: Feb 2020
# Nepal soft drink Company has a soft drink product which has a constant annual demand
rate of 3000 cases and cost Rs. 200/case. If ordering cost is Rs.20 and inventory holding cost
are charged at 25%, what is the EOQ for this product? Also determine the cycle time (in
days).
Past Question: Feb 2020
# A company currently has 200 units of a product on hand that it orders every two weeks
when the salesperson visits the premises. Demand for the product averages 20 units per day
with a standard deviation of 5 units. Lead time for the product to arrive is seven days.
Management has a goal of a 95 percent probability of not stocking out for this product. The
salesperson is due to come in late this afternoon when 180 units are left in stock (assuming
that 20 are sold today). How many units should be ordered?
2020 PU
■ A laboratory orders a number of chemicals from the same suppliers every 30 days. Lead
time is 5 days. The assistant manager of the lab must determine how of one of these
chemicals to order. A check of stock revealed that eleven 25ml jars are on hand. Daily
usage of the chemicals is approximately normal with a mean of 15.2 ml per day and a
standard deviation of 1.6 ml per day. The desired service level for this chemical is 95%.
Required:
How many jars of chemicals to be ordered?
What is the average amount of safety stock of the chemical?
 Extras

(Slides after “Extras” are supplementary content)

 Material handling
■ One of the important features of conversion process is movement
from one place to another, one department to another, one machine
to another machine.
■ This movement directly affects cost and quality of goods and
services.
■ It is a major consideration for effective and efficient production
system.
■ Therefore, it has to be considered as a separate discipline of study.
■ Material handling includes handling of all those transportation or
movement activities of materials, work in process, supplies from
one place to another place.
- The major objectives of the study of material handling are as
follows:
– It helps to reduce need for handling from one place to another place by
eliminating unnecessary movements of men and machines.
– It reduces the cost of movements and transportations.
- Following factors should be considered in developing material
handling system.
– Types of production system
– Capacity of equipment
– Weight of container
– Volume of materials
– Nature of materials
– Method of packing
– Size of load
 Warehousing
■ Act of storing goods or raw materials that will be sold/use or
distributed later.
■ Traditionally a warehouse was taken as a place to hold or store
inventory.
■ In contemporary logistics systems, warehouse is not limited to
storing inventory and viewed as a function that mixes inventory
arrangements to meet customer requirements.
■ Modern warehousing focuses on storing inventory at a minimum
cost and thus the term “warehousing” is referred as transportation
at zero mile per hour.
 Strategic Importance of Warehousing
■ Strategic warehousing offers manufacturers a way to
reduce holding costs.
■ Modern warehouse adopts the notion of JIT (Just In Time),
that is to improve the performance by reducing the
inventory.
■ Strategic warehousing maximizes the flexibility to
respond the ever-changing customer demand.
■ The use of Information technology will allow warehouses
to quickly react to ever-changing customer requirements.
A distribution center (DC) experiences an average weekly demand of 50 units of one of
items. The product is valued at $650 per unit. Average inbound shipments from the factory
warehouse average 350 units. Average Lead time (including ordering delays and transit
time) is 2 weeks. The DC operates 52 weeks per year; it carries a 1 week supply of
inventory as safety stock and no anticipation inventory. What is the average aggregate
inventory being held by the DC.

Solution:
Type of Inventory Calculation of Average Inventory Quantity Total

Average Cycle Inventory Q/2 = 350/2 175 units

Safety Stock Inventory 1 week supply 50 units

Anticipation Inventory None 0 units

Pipeline Inventory tL = (50 units per week)(2 weeks) 100 units

Average Aggregate Inventory 325 units

Note: please refer to Types of Inventory for clarity.