UNIVERSITI UTARA MALAYSIA

PROGRAM: EXECUTIVE DIPLOMA IN TECHNOLOGY MANAGEMENT

MODULE: PROCUREMENT & INVENTORY MANAGEMENT

PREPARED FOR: MR. AZIZ

PREPARED BY: MD. AZARUDDIN BIN MOHAMAD 720911-01-6093

TRUE/FALSE

1.

In cycle counting, the frequency of item counting and stock verification usually varies from item to item depending upon the item's classification. True

2.

Retail inventory that is unaccounted for between receipt and time of sale is known as shrinkage. True

3.

The demand for automobiles would be considered an independent demand. True

4.

Insurance and taxes on inventory are part of the costs known as setup or ordering costs. False

5.

If setup costs are reduced by substantial reductions in setup time, the production order quantity is also reduced. True

6.

The EOQ model is best suited for items whose demand is dependent on other products. False

7.

In the simple EOQ model, if annual demand were to increase, the EOQ would increase proportionately. False

8.

At the economic order quantity, holding costs are equal to purchasing costs. False

9.

In the simple EOQ model, if the carrying cost were to double, the EOQ would also

double. False 10. In the production order quantity (POQ) model, inventory does not arrive in a single moment but flows in at a steady rate, resulting in a larger lot size than in an otherwise identical EOQ problem. True

MULTIPLE CHOICE
1. The two most basic inventory questions answered by the typical inventory model are a. timing and cost of orders b. quantity and cost of orders c. timing and quantity of orders d. order quantity and service level e. ordering cost and carrying cost 2. Among the advantages of cycle counting is that it a. makes the annual physical inventory more acceptable to management b. does not require the detailed records necessary when annual physical inventory is used c. does not require highly trained people d. allows more rapid identification of errors and consequent remedial action than is possible with annual physical inventory e. does not need to be performed for less expensive items 3. Which of the following are elements of inventory holding costs? a. housing costs b. material handling costs c. investment costs d. pilferage, scrap, and obsolescence e. All of the above are elements of inventory holding cost. Which of the following is not an assumption of the economic order quantity model shown below? Q * =
2 D S H

4.

a. Demand is known, constant, and independent. b. Lead time is known and constant. 4

c. Quantity discounts are not possible. d. Production and use can occur simultaneously. e. The only variable costs are setup cost and holding (or carrying) cost. 5. The primary purpose of the basic economic order quantity model shown below is
Q* = 2 D S H

a. to calculate the reorder point, so that replenishments take place at the proper time b. to minimize the sum of carrying cost and holding cost c. to maximize the customer service level d. to minimize the sum of setup cost and holding cost e. to calculate the optimum safety stock 6. If the actual order quantity is the economic order quantity in a problem that meets the assumptions of the economic order quantity model shown below, the average amount of inventory on hand
Q* = 2 D S H

a. is smaller the smaller is the holding cost per unit b. is zero c. is one-half of the economic order quantity d. is affected by the amount of product cost e. All of the above are true. 7. A certain type of computer costs $1,000, and the annual holding cost is 25%. Annual demand is 10,000 units, and the order cost is $150 per order. What is the approximate economic order quantity? a. 16 b. 70 c. 110 d. 183 5

e. 600 8. Most inventory models attempt to minimize a. the likelihood of a stockout b. the number of items ordered c. total inventory based costs d. the number of orders placed e. the safety stock 9. In the basic EOQ model, if the cost of placing an order doubles, and all other values remain constant, the EOQ will a. increase by about 41% b. increase by 100% c. increase by 200% d. increase, but more data is needed to say by how much e. either increase or decrease 10. In the basic EOQ model, if D=6000 per year, S=$100, H=$5 per unit per month, the economic order quantity is approximately a. 24 b. 100 c. 141 d. 490 e. 600

FILL-IN-THE BLANK

1.

In an economic order quantity problem, the total annual cost curve is at its _____________ where holding costs equal setup costs. minimum

2.

For a given level of demand, annual holding cost is larger as the order quantity is _____________. larger

3.

A(n) __________ model gives satisfactory answers even with substantial variations in its parameters. robust

4.

In the production order quantity model, the fraction of inventory that is used immediately and not stored is represented by the ratio of_____________. demand rate to production rate

5.

_____________ is extra stock that is carried to serve as a buffer. Safety stock

6.

In a quantity discount problem, if the savings in product cost is smaller than the increase in the sum of setup cost and holding cost, the discount should be _____________. rejected or refused

7.

____________ is the complement of the probability of a stockout. Service level

8.

If a safety stock problem includes parameters for average daily demand, standard deviation of demand, and lead time, then _____________ is variable and ___________ is constant.

demand, lead time 9. When demand is constant and lead time is variable, safety stock computation requires three inputs: the value of z, _____________, and the standard deviation of lead time. daily demand 10. A(n) ____________ system triggers inventory ordering on a uniform time frequency. fixed-period

SHORT ANSWERS
1. List the typical components that constitute inventory holding or carrying costs. Typical components of inventory holding or carrying costs include housing costs, material handling costs, labor cost from extra handling, investment costs, pilferage, scrap, and obsolescence. 2. Describe the costs associated with ordering and maintaining inventory. Costs that are associated with ordering and maintaining inventory include initial purchase cost of the item, holding cost (insurance, space, heat, light, security, warehouse personnel, etc.), obsolescence or deterioration cost (particularly important in perishable goods or in a product that is undergoing rapid technological evolution), and ordering or setup cost (cost of forms, clerical processing, etc., or cost of machine setup). 3. List the typical cost components that constitute ordering costs in inventory systems. Typical components of ordering costs include cost of supplies, forms, order processing, clerical support, and so forth. 4. Compare the assumptions of the production order quantity model to those of the basic EOQ model. All are the same, except the assumption that receipt of inventory is instantaneous, which holds for EOQ, but not POQ. 5. In some inventory models, the optimal behavior occurs where ordering costs and carrying costs are equal to one another. Provide an example of a model where this "rule" does not hold; explain how the model's results are optimal anyway. This rule will not hold in all instances of quantity discount models. In order to take advantage of a discount, it may be cheaper to order a quantity that is not an EOQ. The goal in quantity discount models is to minimize the sum of ordering, carrying, and purchase costs.

6.

In the basic economic order quantity model and in the production order quantity model, optimal behavior occurs where annual setup costs equal annual holding costs. Is this a coincidence, or a fundamental element of these models? Answer in a well-constructed paragraph. This equality is not a coincidence. It follows from the objective of both models, which is the minimization of total inventory costs for that product. In both of these models, total cost minimization occurs where the setup cost and holding cost elements intersect. The formulas for Q* and Q*P follow from that point of equality.

7.

What are the assumptions of the EOQ model? The more important assumptions of the basic EOQ model are demand is known and constant over time, the lead time, that is, the time between the placement of the order and the receipt of the goods, is known and constant, the receipt of the inventory is instantaneous; i.e., the goods arrive in a single batch, at one instant in time, quantity discounts are not possible, the only variable costs are the cost of setting up or placing an order and the cost of holding or storing inventory over time, and if orders are placed at the right time, stockouts or shortages can be completely avoided.

8.

Assume two inventory problems with identical demand, holding cost, and setup cost. In one, goods arrive instantly, but in the other goods arrive at a measurable rate. Which of these problems will have the larger optimal order quantity? Why? The problem with instantaneous delivery is an EOQ problem, and its optimal order quantity is Q*. The problem with noninstantaneous delivery is a POQ problem, with optimal order quantity Q*P. The POQ problem will yield a higher order quantity than the basic model, other things equal, because the maximum inventory level (and thus the effective carrying charge) is less. Maximum inventory is less because some items are used immediately and never enter inventory.

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9.

How sensitive is the EOQ to variations in demand or costs? The EOQ is relatively insensitive to small changes in demand or setup or carrying costs because the cost curve is relatively flat around the EOQ. For example, if demand increases by 10%, EOQ will increase by approximately 5%.

10.

What is a reorder point? A reorder point is the inventory level (point) at which action is taken (an order placed) to replenish the stocked item.

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PROBLEMS
1. A printing company estimates that it will require 1,000 reams of a certain type of paper in a given period. The cost of carrying one unit in inventory for that period is 50 cents. The company buys the paper from a wholesaler in the same town, sending its own truck to pick up the orders at a fixed cost of $20.00 per trip. Treating this cost as the order cost, what is the optimum number of reams to buy at one time? How many times should lots of this size be bought during this period? What is the minimum cost of maintaining inventory on this item for the period? Of this total cost, how much is carrying cost and how much is ordering cost? This is an EOQ problem, even though the time period is not a year. All that is required is that the demand value and the carrying cost share the same time reference. This will require approximately 3.5 orders per period. Setup costs and carrying costs are each $70.71, and the annual total is $141.42.
EOQ =

1000 2 1000 20 = 3.54 = 283 ; N = 282 .84 0.50 282 .84 1000 .50 = 70 .71 ; setup cost = 20 = 70 .71 2 282 .82

Carrying cost =

2.

The Rushton Trash Company stocks, among many other products, a certain container, each of which occupies four square feet of warehouse space. The warehouse space currently available for storing this product is limited to 600 square feet. Demand for the product is 15,000 units per year. Holding costs are $4 per container per year; Ordering costs are $5 per order. a. What is the cost-minimizing order quantity decision for Rushton? b. What is the total inventory-related cost of this decision? c. What is the total inventory-related cost of managing the inventory of this product, when the limited amount of warehouse space is taken into account? d. What would the firm be willing to pay for additional warehouse space? The warehouse will hold only 150 containers. The annual cost at Q=150 is 100 x 5 + 75 x 4 = $800. The EOQ is about 194, more than there is room to store.

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Total cost at Q=194 is $774.60 This cost is $25.40 less than current cost, which reflects the limited storage space. Rushton would consider paying up to $25.40 for a year's rental of enough space to store 44 additional containers. 3. Given the following data: D=65,000 units per year, S = $120 per setup, P = $5 per unit, and I = 25% per year, calculate the EOQ and calculate annual costs following EOQ behavior. EOQ is 3533 units, for a total cost of $4,415.88
Q* =
TC =

2 65000 120 = 3532 .7 .25 5

D Q 65000 3533 S + H = 120 + .25 5 = 2207 .94 + 2207 .94 = 4415 .88 Q 2 3533 2

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4.

A toy manufacturer makes its own wind-up motors, which are then put into its toys. While the toy manufacturing process is continuous, the motors are intermittent flow. Data on the manufacture of the motors appears below. Annual demand (D) = 50,000 units Setup cost (S) = $85 per batch Carrying cost = $.20 per unit per year a. To minimize cost, how large should each batch of subassemblies be? b. Approximately how many days are required to produce a batch? c. How long is a complete cycle? d. What is the average inventory for this problem? e. What is the total inventory cost (rounded to nearest dollar) of the optimal behavior in this problem? (a) Q * P =
2 DS = H (1 d / p ) 2 * 50000 * 85 = 7288 .7 or 7289 units. .2 * (1 200 / 1000 )

Daily subassembly production rate = 1,000 Daily subassembly usage rate = 200

(b) It will take approximately 7289/ 1000 = 7.3 days to make these units. (c) A complete cycle will last approximately 7289 / 200 = 36 days.
d 200 = 5831 (d) The maximum inventory level is Q 1 = 7288 .7 1 p 1000

units. Average inventory is 5831 / 2 = 2,915 (not one-half of 7283). (e) Total inventory management costs are
TC = 50000 5831 85 + .2 = 583 .09 + 583 .09 = $1,166 .19 7289 2

5.

Louisiana Specialty Foods can produce their famous meat pies at a rate of 1650 cases of 48 pies each per day. The firm distributes the pies to regional stores and restaurants at a steady rate of 250 cases per day. The cost of setup, cleanup, idle time in transition from other products to pies, etc., is $320. Annual holding costs are $11.50 per case. Assume 250 days per year.

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a. Determine the optimum production run. b. Determine the number of production runs per year. c. Determine maximum inventory. d. Determine total inventory-related (setup and carrying) costs per year. (a) Q * P =
2 DS = H (1 d / p ) 2 * 62500 * 320 = 2024 .7 or 2025 cases. 11 .5 * (1 250 / 1650 )

(b) There will be 62,500 / 2024.7 = 30.87 runs per year.

d 250 = 1717 .9 (c) The maximum inventory level is Q 1 = 2024 .7 1 p 1650

units. (d) Total inventory management costs are

TC = 62500 1717 .9 320 + 11 .5 = 9878 .04 + 9878 .04 = $19 ,756 .09 2024 .7 2

6.

Holstein Computing manufactures an inexpensive audio card (Audio Max) for assembly into several models of its microcomputers. The annual demand for this part is 100,000 units. The annual inventory carrying cost is $5 per unit and the cost of preparing an order and making production setup for the order is $750. The company operates 250 days per year. The machine used to manufacture this part has a production rate of 2000 units per day. a. Calculate the optimum lot size. b. How many lots are produced in a year? c. What is the average inventory for Audio Max?

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d. What is the annual cost of preparing the orders and making the setups for Audio Max? This problem requires the production order quantity model. The optimum lot size is 6,124; this lot size will be repeated 16.33 times per year. The total inventory management cost will be $24,494.90, and average inventory will be 2,449.49 units. (a) Q * P =
2 DS = H (1 d / p ) 2 * 100000 * 750 = 6123 .7 or 6124 units. 5.00 (1 40 / 100 )
D 100000

(b) There are approximately N = Q = 6123 .7 = 16 .33 cycles per year.

(c) The maximum inventory is Q 1 = 6123 .7 1 d p 40 = 4899 units; 100

average inventory is 4899 / 2 = 2449.5 units. (d) Annual inventory management costs are 16.33 x 750+ 2449.5 x 5 = $12,247.45+$12,247.45 = $24,494.90

7.

Huckaby Motor Services, Inc. rebuilds small electrical items such as motors, alternators, and transformers, all using a certain type of copper wire. The firm's demand for this wire is approximately normal, averaging 20 spools per week, with a standard deviation of 6 spools per week. Cost per spool is $24; ordering costs are $25 per order; inventory handling cost is $4.00 per spool per year. Acquisition lead time is four weeks. The company works 50, 5-day weeks per year. a. What is the optimal size of an order, if minimization of inventory system cost is the objective? b. What are the safety stock and reorder point if the desired service level is 90%? Demand is 20 x 50 = 1000 spools per year a. Q * =
2 20 50 25 = 111 .8 . Huckaby should order 112 spools at one time. 4

b. SS = 1.29 6 4 = 15 .48 or about 16 spools. The ROP is thus 20 4 + 16 = 96 spools.

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8.

Demand for ice cream at the Ouachita Dairy can be approximated by a normal distribution with a mean of 47 gallons per day and a standard deviation of 8 gallons per day. The new management desires a service level of 95%. Lead time is four days; the dairy is open seven days a week. What reorder point would be consistent with the desired service level? SS = 1.65 8
4

= 26.4 gallons; and ROP = 47* 4 + 26.4 = 214.4 gallons.

9.

The Winfield Distributing Company has maintained an 80% service level policy for inventory of string trimmers. Mean demand during the reorder period is 170 trimmers, and the standard deviation is 60 trimmers. The annual cost of carrying one trimmer in inventory is $6. The area sales people have recently told Winfield's management that they could expect a $400 improvement in profit (based on current figures of cost per trimmer) if the service level were increased to 99%. Is it worthwhile for Winfield to make this change? This is solved with a cost comparison: total costs status quo compared to total costs at higher service, as amended by the increased profit. First calculate their safety stock. SS = 0.84 60 = 50.4 trimmers at $6 each, this safety stock policy costs about $302.40. At a service level of 99%, the safety stock rises to 2.33 60 = 139.8, which will cost $838.80. The added cost is $536.40, which is more than the added profit, so Winfield should not increase its service level.

10.

Daily demand for a product is normally distributed with a mean of 150 units and a standard deviation of 15 units. The firm currently uses a reorder point system, and seeks a 75% service level during the lead time of 6 days. a. What safety stock is appropriate for the firm? b. What is the reorder point? SS = 0.67 15
6

= 26.6; ROP = 150 6 + 26.6 = 926.6

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