Note 4: Single-stage Inventory Control I

Economic Order Quantity (EOQ) Model

The EOQ specifies a (Q, r) inventory policy for determining how much and when to order.
When the inventory position drops to r units, we initiate an order for Q units.
Total Cost AD hQ
= + CD + ; (1)
Time Q 2
where:
A = fixed cost to place an order;
D = demand rate in units per time;
C = unit purchase cost of product;
h = inventory holding cost per unit-time, which is ηC;
τ = lead time for order delivery. q
By differentiation, we find the optimal order quantity Q∗ = 2AD/h. The reorder point
r = τ D.
Example: A manufacturing facility uses lumber to construct shipping crates for products.
The facility uses 250 8-foot boards per week. The supervisor estimates a fixed cost of $80 to
place an order for paperwork preparation. Lumber costs $2.25 per board, and the company
uses a carrying cost rate of 50% per year. The plant operates fifty weeks per year. It takes
two weeks to receive a shipment. Find the optimal order quantity and reorder point.
A = 80, D = 250 × 50 = 12500, h = 2.25 × 0.5 = 1.125.
Total relevant cost T RC(Q) = AD/Q + hQ/2. We have
T RC(Q) 1 Q∗ Q
∗
= [ + ∗ ]. (2)
T RC(Q ) 2 Q Q
For instance,
T RC(Q = 1.5Q∗ ) 1 1 1.5
∗
= [ + ] = 1.083.
T RC(Q ) 2 1.5 1

Little’s Law
L = λW .

Economic Manufacturing Quantity (EMQ) Model

To account for the WIP cost, we let M be the cost of the raw material (per unit of
product) and ν be the value added by the process. Thus, the cost of a completed item is
C = M + ν. Because the product increases in value from M to M + ν during production,
we approximate the value of an in-process unit by M + ν/2. By Little’s Law, we have
Average Number of Batches in Process
Average Throughput Time = . (3)
Available Rate of Batches

1
We let w be the ratio of throughput time to processing time for the facility.
Example: A facility produces 100 batches per 40-hour work week. Actual processing
time per batch averages four hours. Records show an average of 30 batches are in process at
any time. Estimate throughput time and w (12 hrs and 3).
Inventory cost rate is

Total Cost AD ν η(M + ν)Q

= + M D + η(M + )(s + pQ)Dw + . (4)
Time Q 2 2
After differentiation, we have
s
∗ 2AD
Q = . (5)
η[(M + ν) + 2pDw(M + ν/2)]

Example: Each year, 1500 castings are purchased from a foundry as needed for $18 each.
They undergo finishing machining operations before being stocked for final assembly. The
machine takes fifty minutes to set up, and each piece is machined for fifteen minutes. The
machining work center is charged out at $30 per hour, including labor. A study has shown
that jobs spend about three-fourths of their time in the shop waiting and in-transport (the
other one-fourth is spent in setup and processing time). In addition to machine setup, each
batch incurs an $80 charge for ordering castings. The carrying cost rate for the company
is 40% per year. The plant is scheduled to operate 2500 hours per year. Find the optimal
production lot size.
C = 25.5, A = 105.

Price Breaks
Example: An assembly plant purchases 35000 air filters per year. Fixed ordering cost
is $100. The company uses an inventory holding cost rate of .4 per year. The vendor has
offered the following price schedule. For orders of more than 5000, unit cost is $2.5. For
orders between 1000 and 5000, filters cost $2.65. Orders less than 1000 have a cost of $2.85
per filter. Find the optimal order quantity.

Rotation Cycle Policies

Total cost is a function of rotation cycle T :
n
Total Cost X Ai η(Mi + νi )T Di νi
= [ + Ci Di + + η(Mi + )Di (si + pi T Di )w]. (6)
Time i=1 T 2 2

We can find: v
2 nj=1 Aj
u P
∗
u
T = t Pn . (7)
η j=1 Dj [(Mj + νj ) + 2wDj pj (Mj + νj /2)]

2
We also need n
X
(sj + pj Dj T ) ≤ T. (8)
j=1

Let T min = ( nj=1 sj )/(1 − nj=1 pj Dj ), we let T OP T = max{T ∗ , T min }.

P P

Example: A bottle-filling machine fills 20-oz plastic bottles with four different syrups.
The machine usually operates 200 hours per month, and each changeover between syrups
takes one hour and costs $100. The machine can bottle 3000 bottles per hour. The production
system operates as a flow line, thus bottles enter the line and are immediately filled, capped,
packaged, and shipped to the warehouse. Material cost is $0.16 per bottle, and the value
added from bottling is calculated at $0.04. The holding cost rate is 5% per month. Additional
details are; D1 = 250000, D2 = 25000, D3 = 25000, and D4 = 125000. Find the optimal
rotation cycle time and batch size.