Tutorial Chapter 7: Inventory

Management
Prepared by

Dr Noor Ajian Mohd Lair

Senior Lecturer
Mechaincal Engineering Program
Faculty of Engineering
Universiti Malaysia Sabah

Office No 43, 2nd floor

Ext: 3422
email: nrajian72@gmail.com
 Example 1: ABC Analysis
• Silicon Chips Inc. ITEM STOCK
ANNUAL
VOLUME
NUMBER (UNITS) UNIT COST ($)
maker of superfast #01036 100 8.50
DRAM chips, wants to #01307 1,200 .42

catagorize its 10 #10286 1,000 90.00

major inventory items #10500 1,000 12.50

#10572 250 .60
using ABC analysis. #10867 350 42.86
• The stock number, #11526 500 154.00

annual volume and #12572 600 14.17

#12760 1,550 17.00
unit cost is given in
#14075 2,000 .60
table.
 Example 1: ABC Analysis
• Solution.
1. Multiple the Annual Volume (3) with Cost per Unit (4) for
each item to get the Annual Dollar Volume (5).
2. Sort the items on an the Annual Dollar Volume (5) basis
(decreasing values)
3. Calculate the summation of the Annual Volume and
Annual Dollar Volume.
4. Using the Annual Dollar Volume and the Total Annual
Dollar Volume, calculate the Percentage Annual Dollar
Volume (6) for each item.
5. Using the Annual Volume and the Total Annual Volume,
calculate the Percentage Annual Volume (2) for each item
6. Classify the items as recomended:
• Class A - high annual dollar volume (15% of total inventory
items, 70 to 80% of total annual dollar values)
• Class B - medium annual dollar volume (30% of total inventory
items, 15 to 25% total annual dollar values)
• Class C - low annual dollar volume (55% of total inventory
items, 5% total annual dollar values)
 Example 1: ABC Analysis
ABC Calculation
(1) (2) (3) (4) (5) (6) (7)
PERCENT
OF PERCENT
ITEM NUMBER ANNUAL ANNUAL OF ANNUAL
STOCK OF ITEMS VOLUME UNIT DOLLAR DOLLAR
NUMBER STOCKED (UNITS) x COST = VOLUME VOLUME CLASS
#10286 20% 1,000 $ 90.00 $ 90,000 38.8% A
72%
#11526 500 154.00 77,000 33.2% A
#12760 1,550 17.00 26,350 11.3% B
#10867 30% 350 42.86 15,001 6.4% 23% B
#10500 1,000 12.50 12,500 5.4% B
#12572 600 $ 14.17 $ 8,502 3.7% C
#14075 2,000 .60 1,200 .5% C
#01036 50% 100 8.50 850 .4% 5% C
#01307 1,200 .42 504 .2% C
#10572 250 .60 150 .1% C
8,550 $232,057 100.0%

Therefore, Item #10286 and #11526 classified as catagory A. Item #12760,

© 2014 Pearson Education, Inc. 12 - 4
#10867 and #10500 classified as Catagory B and the rest as Catagory C.
 Example 2: EOQ
▶ Sharp Inc., a company that markets painless hypodermic
needles to hospitals, would like to reduce its inventory
cost by determining the optimal number of hypodermic
needles to obtain per order. The annual demand is
1,000 units; the setup or ordering cost is $10 per order;
and the holding cost per unit per year is $0.50.
▶ Determine:
i. The EOQ
ii. The number of order if it has 250 days working
iii. The expected time between orders and average inventory
iv. The total cost (ordering + holding costs)
v. If the demand is actually 1,500 units (instead of 1,000 units), how
this would impact the annual inventory cost?

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 An EOQ Example
i. Determine optimal number of needles to order
D = 1,000 units
S = $10 per order
H = $.50 per unit per year

2DS
Q* =
H

2(1,000)(10)
Q =*
= 40,000 = 200 units
0.50
Therefore, the economic order quantity is 200 units per order

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 An EOQ Example
ii. Determine expected number of orders
D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year

Expected Demand D
number of = N = =
orders Order quantity Q*

1,000
N= = 5 orders per year
200

Therefore, there are expected 5 orders per year

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 An EOQ Example
iii. Determine optimal time between orders
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders/year
H = $.50 per unit per year
Expected Number of working days per year
time between = T =
orders Expected number of orders
250
T= = 50 days between orders
*
5
Q 200Unit
or T   0.2 year  0.2  250days  50days
D 1000UnitPerYear
iii. Determine the average inventory
Average Q
Inventory = = 200/2 = 100 units
2
Therefore, the optimal time between orders is 50 days and average
© 2014inventory is 100
Pearson Education, Inc.units. 12 - 8
 An EOQ Example
iv. Determine the total annual cost
D = 1,000 units Q* = 200 units
S = $10 per order N = 5 orders/year
H = $.50 per unit per year T = 50 days

Total annual cost = Setup cost + Holding cost

D Q
TC = S + H
Q 2
1,000 200
= ($10) + ($.50)
200 2
= (5)($10) + (100)($.50)
= $50 + $50 = $100
Therefore, the total annual cost is $100
© 2014 Pearson Education, Inc. 12 - 9
 An EOQ Example
v. Determine optimal number of needles
Only 2% to less
order
than
D = 1,000 units 1,500 units Q* =the200total
units
cost of
S = $10 per order N =$125
5 orders/year
when the
H = $.50 per unit per year = 50 days
T order quantity was
200
D Q
TC = S+ H
Q 2
1,500 244.9
=
1,500
($10) +
200
($.50) = ($10) + ($.50)
200 2 244.9 2
= $75 + $50 = $125 = 6.125($10) +122.45($.50)
The total annual cost increase to $125 = $61.25 + $61.22 = $122.47
However, has we known that the demand was for 1,500 units with an EOQ12of- 10
© 2014 Pearson Education, Inc.
244.9 units, we would have spent $122.47.
Example 3: Reorder Points (ROP)
w/o Safety Stock
▶ Apple store has a demand (D) for 8,000
iPods per year. The firm operates a 250-
day working per year. On average,
delivery of an order takes 3 working days,
but has known to take as long as 4 days.
The store wants to calculate the reorder
point without a safety stock and then with
a safety stock.

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 Reorder Point Example
Demand = 8,000 iPods per year
250 working day year
Lead time for orders is 3 working days, may take 4
D
d=
Number of working days in a year
= 8,000/250 = 32 units

ROP = d x L
= 32 units per day x 3 days = 96 units
= 32 units per day x 4 days = 128 units

Therefore, when iPods inventory drops to 96 units, an order should be

©placed. If Education,
2014 Pearson the safety Inc. stock for a possible one day delay is considered then12 - 12
an order should be placed when the inventory drops to 128 units
 Example 4: Production Order
Quantity
▶ Nathan Manufacturing inc. makes and sells
speciallty hubcups for the retail automobile
aftermarket. Nathan's forecast for its wire-wheel
hubcap is 1,000 units next year, with an average
daily demand of 4 units. However, the
production process is most effcient at 8 units per
day. So the company produces 8 per day but
uses only 4 per day. The company wants to
solve for the optimum number of units per order.
(Note: this plant schedules production of this
hubcap only as needed, during the 250 days per
year the shop operates.)

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 Production Order Quantity
Example
D = 1,000 units p = 8 units per day
S = $10 d = 4 units per day
H = $0.50 per unit per year

2DS
Q *p =
( )
H éë1- d p ùû

2(1,000)(10)
Q *p =
0.50éë1- (4 8)ùû

20,000
= = 80,000
0.50(1 2)
= 282.8 hubcaps, or 283 hubcaps
Therefore, the optimum production order quantity is 283 hubcaps per
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order
Example 5: Quantity Discount
▶ Wohl's Discount Store stocks toy race cars.
Recently, the store has been given a quantity
discount schedule for these cars. This quantity
schedule was shown inTable 12.2. Thus, the
normal cost for the toy race cars id $5. For orders
between 1,000 and $1,999 units, the unit cost drops
to $4.80; for orders of 2,000 or more units, the unit
cost only $4.75. Furthermore, ordering cost is $49
per order, annual demand is 5,000 race cars, abd
inventory carrying charge, as percent of cost, I is
20%. What order quantity will minimise the total
inventory cost?
DISCOUNT DISCOUNT DISCOUNT
NUMBER PRICE QUANTITY
1 $5.00 0 to 999
2 $4.80 1,000 to 1,999
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3 $4.75 2,000 and over
 Quantity Discount Example
Calculate Q* for every discount 2DS
Q =
*

IP
2(5,000)(49)
Q1* = = 700 cars/order
(.2)(5.00)

2(5,000)(49)
Q2* = = 714 cars/order
(.2)(4.80)

2(5,000)(49)
Q3* = = 718 cars/order
(.2)(4.75)
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 Quantity Discount Example
Calculate Q* for every discount 2DS
Q =
*

IP
2(5,000)(49)
Q1* = = 700 cars/order
(.2)(5.00)

2(5,000)(49)
Q2* = = 714 cars/order
(.2)(4.80) 1,000 — adjusted
2(5,000)(49)
Q3* = = 718 cars/order
(.2)(4.75) 2,000 — adjusted
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 Quantity Discount Example
PXD DS/Q QH/2=Q(0.2P)/2
TABLE 12.3 Total Cost Computations for Wohl’s Discount Store
ANNUAL ANNUAL ANNUAL
DISCOUNT UNIT ORDER PRODUCT ORDERING HOLDING
NUMBER PRICE QUANTITY COST COST COST TOTAL
1 $5.00 700 $25,000 $350 $350 $25,700
2 $4.80 1,000 $24,000 $245 $480 $24,725
3 $4.75 2,000 $23.750 $122.50 $950 $24,822.50

Choose the price and quantity that gives the

lowest total cost
Therefore, Buy 1,000 units at $4.80 per unit

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 Example 6: Safety Stock
▶ David Rivera Optical has NUMBER
PROBABILITY
determined that its reorder OF UNITS
point for eyeglass frames is 50
(d X L) units. Its carying cost 30 .2
per frame per year is $5, and
stockout (or lost sale) cost is 40 .2
$40 per frame. The store has ROP 
.3
experienced the following 50
probability distribution for 60 .2
inventory demand during the
lead time (reorder period). The 70 .1
optimum number of order per
year is six. How much safety 1.0
stock should Rivera keep on
hand?
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 Safety Stock Example
ROP = 50 units Stockout cost = $40 per frame
Orders per year = 6 Carrying cost = $5 per frame per year

NUMBER OF UNITS PROBABILITY

30 .2
40 .2
ROP  50 .3
60 .2
70 .1
1.0

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 Safety Stock Example
ROP = 50 units Stockout cost = $40 per frame
Orders per year = 6 Carrying cost = $5 per frame per year
SAFETY ADDITIONAL TOTAL
STOCK HOLDING COST STOCKOUT COST COST

20 (20)($5) = $100 $0 $100

10 (10)($5) = $ 50 (10)(.1)($40)(6) = $240 $290

0 $ 0 (10)(.2)($40)(6) + (20)(.1)($40)(6) = $960 $960

A safety stock of 20 frames gives the lowest total cost

ROP = 50 + 20 = 70 frames
Therefore, The optical company now knows that a safety stock
of 20 frames will be the most economical decision with
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reorder point of 70 frames
 Example 7: Probabilistic Models
A. Safety Stock with Probabilistic Demands
B. ROP for variable demand and constant
lead time
C. ROP for constant demand and variable
lead time
D. ROP for variable demand and variable
lead time

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 Probabilistic Example A:
Safety Stock with Probabilistic Demands
▶ Memphis Regional Hospital stocks a "code blue"
resuscitation kit that has a normally distributed
demand during the reorder period. The mean
(average) demand during the reorder period is
350 kits, and the standrad deviation is 10 kits.
The hosptial administrator wants to follow a olicy
that results in stockouts only 5% of the time.
determine:
a. What is the appropriate value of Z?
b. How much safety stock should the hospital
maintain?
c. What reorder point should the hospital used?

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 Probabilistic Example A
m = Average demand = 350 kits
sdLT = Standard deviation of
demand during lead time = 10 kits
Z = 5% stockout policy (service level = 95%)

Using Appendix I, for an area under the curve of

95%, the Z = 1.65
Safety stock = ZsdLT = 1.65(10) = 16.5 kits

Reorder point = Expected demand during lead time +

Safety stock
= 350 kits + 16.5 kits of safety stock
= 366.5 or 367 kits
© Therefore, the hospital
2014 Pearson Education, should maintain safety stock of 17 kits and uses
Inc. 12 - 24
reorder point of 367 kits
 Probabilistic Example B:
ROP for variable demand and constant lead
time
▶ The average daily demand for Lenovo
laptop computers at a Circuit Town store is
15, with a standrad deviation of 5 units.
The lead time is constant at 2 days. Find
the reorder point if management wants a
90% service level (ie stock outs only 10%
of the time). How much of this is safety
stock?

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 Probabilistic Example B
Average daily demand (normally distributed) = 15
Lead time in days (constant) = 2
Standard deviation of daily demand = 5
Service level = 90%
Z for 90% = 1.28
From Appendix I
Safety stock = ZsdLT = 9.02 = 9 computers
ROP = (15 units x 2 days) + ZsdLT
= 30 + 1.28(5)( 2)
= 30 + 9.02 = 39.02 ≈ 39

Safety stock is about 9 computers with

reorder points of 39 computers
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 Probabilistic Example C:
ROP for constant demand and variable lead
time
▶ The circuit town store sells about 10
digitals cameras a day (almost a constant
quantity). Lead time for camera delivery is
normally distributed with a mean time of 6
days and a standrad deviation of 1 day. A
98% service level is set. Find the ROP

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 Probabilistic Example C
Daily demand (constant) = 10
Average lead time = 6 days
Standard deviation of lead time = sLT = 1
Service level = 98%, so Z (from Appendix I) = 2.055

ROP = (10 units x 6 days) + 2.055(10 units)(1)

= 60 + 20.55 = 80.55

Reorder point is about 81 cameras

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 Probabilistic Example D:
ROP for variable demand and variable lead
time
▶ The circut town store's most popular item
is six-packs of 9 volt batteries. About 150
packs are sold per day, following a normal
distribution with a standrad deviation of 16
packs. Batteries are ordered from an out-
of-state distributor; lead time is normally
distributed with an average of 5 days and
a standrad deviation of 1 day. To maintain
a 95% service level, what ROP is
appropriate?
© 2014 Pearson Education, Inc. 12 - 29
 Probabilistic Example D
Average daily demand (normally distributed) = 150
Standard deviation = sd = 16
Average lead time 5 days (normally distributed)
Standard deviation = sLT = 1 day
Service level = 95%, so Z = 1.65 (from Appendix I)

ROP = (150 packs ´ 5 days) +1.65s dLT

s dLT = ( ) ( ) (5 ´ 256) + (22,500 ´1)
5 days ´162 + 1502 ´12 =

= (1,280) + (22,500) = 23,780 @ 154

ROP = (150 ´ 5) +1.65(154) @ 750 + 254 = 1,004 packs
Reorder point is about 1,004 packs
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 The End

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