GSMC520 Unit 6 Learning Activity

Solutions
Instructions

In each unit, students may choose to complete Learning Activities. Prior to working on the
Learning Activities, they should read through the chapters and the unit lesson. If a student
feels he or she understands the concepts in the reading, he or she may not need to
complete all of the Learning Activities. However, working on the Learning Activities will
increase confidence with the concepts. Students should be encouraged to complete all of
the practice activities.

Upon the professor's review of each practice activity, students will receive constructive
feedback. They should clearly identify their work with their names, the date, the unit
number, and the practice activity page number or name. Students should make sure to e-
mail their professor whenever they upload work (activities or assessments) to the
Dropbox.

Upon submission, the professor should review of each practice activity and provide
constructive feedback. Students may submit as many of the Learning Activities from the six
available as they want. If all goes well, a student will e-mail the professor whenever he or
she has uploaded work (activities or assessments) to the Dropbox. You should e-mail the
student after the assignment has been reviewed.

Activity 1: CO 3, Competencies C, D, and E

Chapter 13 (pp. 453–455): Review and Discussion Questions 1–6 and Problems 1–4

Review and Discussion Questions 1–6

1. What recent changes have caused supply chain management to gain importance?

Answers
Changes include the following.
a. Competitive pressures from foreign firms
b. Elevation of product quality to a very high level of importance
c. International marketing and international purchasing
d. Trends towards choosing sole-source suppliers and long-term relationships
e. Product varieties and ranges that are rapidly changing, with speed of delivery to
market essential
f. Product life cycles shortening, necessitating knowledge and control of inventories in
the various pipelines

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GSMC520 Unit 6 Learning Activity
Solutions
g. Adoption of JIT production changing supplier relationships and increasing the focus
on reducing inventories
h. Trends in the legal system holding manufacturers liable for product failures, even
though causes of failure may lie outside of the production system itself
i. Use of EDI in purchasing
j. The growth of supplier development

2. With so much productive capacity and room for expansion in the United States, why would
a company based in the United States choose to purchase items from a foreign firm?
Discuss the pros and cons.

Answer
The use of foreign firms can provide a U.S. firm more alternatives in selecting a supplier. The
pros are more choices; potentially reduced costs in the areas of materials, transportation,
production, and distribution; and potentially moving closer to a foreign market. The cons
are: the distance is generally increased; communications problems are increased due to
distance, culture, and technology; and there may be problems with customs, government
regulations, political stability, and so on.

3. Describe the differences between functional and innovative products.

Answer
Functional products are staples that people buy in a wide range of retail outlets. Typically,
they do not change much over time and they have low profit margins, stable and
predictable demand, and long life cycles. Innovative products, on the other hand, give
customers additional reasons to buy. Fashionable clothes and personal computers are
examples of innovative products. Innovative products have short life cycles, high profit
margins, and volatile demand.

4. What are characteristics of efficient, responsive, risk-hedging, and agile supply chains? Can
a supply chain be both efficient and responsive? Risk hedging and agile? Why or why not?

Answer
Efficient supply chains are designed to minimize costs, which requires high utilization,
minimizing inventory, selecting vendors based primarily on cost and quality, and designing
products that are produced at minimum cost. Market-responsive supply chains are
designed to minimize lead time to respond to unpredictable demand, thus minimizing
stockout costs and obsolete inventory costs. Risk-sharing supply chains are those that share
resources so that risks in the supply chain can be shared. Agile supply chains are those that

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GSMC520 Unit 6 Learning Activity
Solutions
are flexible while still sharing risks of shortages across the supply chain. Generally, these
supply chains carry excess capacity and higher buffer stocks. Vendors in responsive supply
chains would be selected for speed, flexibility, and quality. It is possible to be both efficient
and responsive, and both risk-hedging and agile, but Exhibit 13.4 helps illustrate why supply
chains are generally not both.

5. As a supplier, which factors would you consider about a buyer (your potential customer) to
be important in setting up a long-term relationship?

Answer
The financial stability and credit worthiness of the company is of primary importance. The
reputation of the company vis-à-vis its supplier is also very important. For example, is this a
company that is fair with its suppliers and honors its payables in a timely fashion? Is the
technological match between supplier and customer sufficient? Will delivery schedules and
quantities be stable, facilitating smooth operations?

6. Describe how outsourcing works. Why would a firm want to outsource?

Answer
Outsourcing is the act of moving some of a firm's internal activities and decision
responsibilities to outside providers. The terms of the agreement are established in a
contract. Outsourcing goes beyond the more common purchasing and consulting contracts
because not only are the activities transferred, but resources that make the activities occur
are also transferred. Reasons for outsourcing are listed in Exhibit 13.6. Some of the major
categories from this exhibit include organizational, improvement, financial, revenue, cost,
and employee-driven reasons.

Problems 1, 2, 3, and 4

1.
Answer
Year: 0 1 2 3
Demand 200,000 300,000 500,000
Cost of Capital 0.15
Purchase Option
Purchase Cost Per
0.1 $20,000.00 $30,000.00 $50,000.00
Unit
Shipping/Unit 0.01 $2,000.00 $3,000.00 $5,000.00

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GSMC520 Unit 6 Learning Activity
Solutions
Inventory
0.005 $1,000.00 $1,500.00 $2,500.00
Charge/Unit
Monthly Charge 20 $240.00 $240.00 $240.00
Total Purchase Cost $23,240.00 $34,740.00 $57,740.00

Make Option
Direct Material 0.05 $10,000.00 $15,000.00 $25,000.00
Direct Labor 0.03 $6,000.00 $9,000.00 $15,000.00
50% Surcharge 0.015 $3,000.00 $4,500.00 $7,500.00
Indirect Labor 0.011 $2,200.00 $3,300.00 $5,500.00
50% Surcharge 0.0055 $1,100.00 $1,650.00 $2,750.00
Overhead 100%
0.03 $6,000.00 $9,000.00 $15,000.00
DL
Total Variable Manufacture Cost $28,300.00 $42,450.00 $70,750.00
$30,000.0
Investment Engineer
0
$10,000.0
Equipment
0

Cost Comparison Analysis

$40,000.0
Make Cost – Buy Cost $5,060.00 $7,710.00 $13,010.00
0
Discount Factor 1 0.86957 0.75614 0.65752
$40,000.0
NPV (Make – Buy) $4,400.00 $5,829.87 $8,554.29
0
Total NPV
(Make – Buy) $58,784.15

Alternative: Option NPV Calculations

$143,226.2 $40,000.0
Buy
7 0 $24,608.70 $32,098.30 $46,519.27
Make $84,442.11 $20,208.70 $26,268.43 $37,964.99
Difference $58,784.15

Continuing to make in-house would cost us over $58,000 more in current dollars than
buying from the supplier. We should accept the bid.

2.

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GSMC520 Unit 6 Learning Activity
Solutions
Answer
Requirement (annual
forecast) 12,000.00 units
Weight 22 pounds per engine
Order Processing Cost $125.00 per order
Inventory Carry Cost 20% of average inventory

Lot Size (order quantity) 1,000 Units - given in the case

Supplier 1 2
Unit Price $510 $505
Annual Purchase Cost $6,120,000 $6,060,000
One-Time Tooling Cost $22,000 $20,000
Orders per Year 12 12
Order Processing Cost $1,500 $1,500
Inventory Carry Cost $51,000 $50,500

Distance 125 100 miles

Weight per Load 22,000

Transportation (less than truckload)
$1.20 per 2,000 lbs. per
Mile $19,800 $15,840

$66,46
Total Cost $6,214,300 $6,147,840 0 difference
We would prefer supplier
#2.

Required lot size for Units (40,000 lbs. max. load / 22 lbs. per
truckload 1,818 engine)

Supplier 1 2
Unit Price $500 $505
Annual Purchase Cost $6,000,000 $6,060,000
One-Time Tooling Cost $22,000 $20,000
Orders per Year 6.6 6.6
Annual Order Processing
Cost $825 $825

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GSMC520 Unit 6 Learning Activity
Solutions
Annual Inventory Carry Cost $90,900 $91,809

Distance 125 100 miles

Weight per Load 40,000

Transportation (truckload)
$0.80 per 2,000 lbs. per $13,200 $10,560
Mile

Total Cost $6,126,925 $6,183,194 $56,26 difference

9

Yes, it would make sense to order in truckload lots because we can reduce total costs.
Although carrying costs increase, purchase and transportation costs decrease by a greater
amount. Note that if ordering in truckload lots, Supplier 1 becomes the lowest choice option.

In future years, the cost would be reduced by the one-time tooling cost included here.

3.
Answer

Cost of Goods Sold 1 .00∗1000∗52

Inventory Turnover= = =148. 6
Average Aggregate Inventory Value 350

The problem tells us that we sell 4,000 quarter-pound burgers a week—meaning we sell 1,000
pounds a week—and each pound of hamburger costs $1.00. The problem also tells us that on
average, the store has 350 pounds of inventory on hand. By dividing the Cost of Goods Sold by
Average Aggregate Inventory Value, we can figure the inventory turns. This means that
inventory turns 148.6 times a year.

Average Aggregate Inventory Value 350

Weeks of Supply= ∗52= ∗52=. 350
Cost of Goods Sold 1 . 00∗1000∗52
On average, the restaurant has about a third of a week’s supply on hand.

4.
Answer

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GSMC520 Unit 6 Learning Activity
Solutions
Q1 Q2 Q3 Q4
Sales
United States 300 350 405 375
Canada 75 60 75 70
Europe 30 33 20 15
COGS (total) 280 295 340 350
Inventory
Raw Materials 50 40 55 60
WIP and FG 100 105 120 150
DC Inventory
United States 25 27 23 30
Canada 10 11 15 16
Europe 5 4 5 5

Total Inventory 190 187 218 261

Inventory Turnover 1.5 1.6 1.6 1.3

Using the end-of-quarter inventory numbers as a substitute for the average inventory level, we
have the following quarterly and annual inventory turn values. Average inventory for the
annual figure is based on the average of the four quarterly inventory numbers.

Q1 Q2 Q3 Q4 Annual
280 / 190 = 295 / 187 = 340 / 218 = 350 / 261 = 1,265 / 214 =
1.474 1.578 1.560 1.341 5.911

If you were given the assignment to increase inventory turnover, what would you focus on?
Why?

To increase the inventory turns, a firm needs to reduce the amount of inventory, increase sales,
or do both. To increase turns, the item most readily within our control is the amount of
inventory that the firm has on hand. The raw materials, WIP, and FG inventories are the most
obvious targets for reduction.

The company reported that it used 500 M worth of raw material during the year. On average,
how many weeks supply of the raw material are on hand at the factory?

Average Aggregate Inventory Value 214

Weeks of Supply= ∗52= ∗52=8 .797
Cost of Goods Sold 1265

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GSMC520 Unit 6 Learning Activity
Solutions
The 500 M does not come into play in this problem.

Activity 2: CO 3, Competencies C, D, and E

Chapter 13 (pp. 455–457): Analytics Exercise: Global Sourcing Decisions—Granger:
Reengineering the China-U.S. Supply Chain

Evaluate the scenario and answer the following questions from the textbook in an APA-
formatted paper of approximately three pages.

1. Evaluate the current China-Taiwan logistics costs. Assume a current total volume of 190,000
CBM, with the 89% shipped direct from the supplier plants in containers. Use the data from
the case and assume that the supplier-loaded containers are 85% full. Assume that
consolidation centers are run at each of the four port locations. The consolidation centers
only use 40’ containers and fill them to 96% capacity. Assume that it costs $480 to ship a 20’
container and $600 to ship a 40’ container. What is the total cost to get the containers to
the United States? Do not include U.S. port costs in this part of the analysis.

Answer

Basic Data
Total Current Volume (CBM) 190,000
Direct Ship Percentage 0.89
Direct Ship Volume (CBM) 169,100
Consolidation Center Volume 20,900

Shipping Cost Calculations

Direct Ship by Container Type 20' 40'
Volume (%) 21% 79%
Volume (CBM) 35,511 133,589
Container Capacity Used 85% 85%

Consolidation Center by Container Type

Volume (%) 100%
Volume (CBM) 20,900
Container Capacity Used 96%

Container Capacity (CBM) 34 67

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GSMC520 Unit 6 Learning Activity
Solutions

Containers Shipped 1,229 2,671

Shipping Cost per Container $ 480.00 $ 600.00
Shipping Costs by Container Size $ 589,920 $ 1,602,600
Total Shipping Cost $ 2,192,520

Consolidation Center Operating Cost

Calculations
Number of Centers 4
Annual Fixed Cost per Center $ 75,000
Total Annual Fixed Cost $ 300,000
Variable Cost per CBM $ 4.90
Total Annual Variable Cost $ 102,410
Total Annual Consolidation Center Costs $ 402,410

Total China-Taiwan Logistics Cost $ 2,594,930

2. Evaluate an alternative that involves consolidating all 20’ volume and using only a single
consolidation center in Shanghai and Ningbo. Assume that all the existing 20’ volume and
existing consolidation center volume is sent to this single consolidation center by suppliers.
This new consolidation center volume would be packed into 40’ containers filled to 96% and
shipped to the United States. The existing 40’ volume would still be shipped direct from the
suppliers at 85% capacity utilization.

Answer

Basic Data
Total Current Volume (CBM) 190,000
Direct Ship Percentage 0.7031
Direct Ship Volume (CBM) 133,589
Consolidation Center Volume 56,411

Shipping Cost Calculations

Direct Ship by Container Type 20' 40'
Volume (%) 0% 100%
Volume (CBM) 0 133,589

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GSMC520 Unit 6 Learning Activity
Solutions
Container Capacity Used 85% 85%

Consolidation Center by Container Type

Volume (%) 100%
Volume (CBM) 56,411
Container Capacity Used 96%

Container Capacity (CBM) 34 67

Containers Shipped 0 3223

Shipping Cost per Container $ 480.00 $ 600.00
Shipping Costs by Container Size $- $ 1,933,800
Total Shipping Cost $ 1,933,800

Consolidation Center Operating Cost

Calculations
Number of Centers 1
Annual Fixed Cost per Center $ 75,000
Total Annual Fixed Cost $ 75,000
Variable Cost per CBM $ 1.40
Total Annual Variable Cost $ 78,975
Total Annual Consolidation Center Costs $ 153,975

Total China-Taiwan Logistics Cost $ 2,087,775

Assuming the new consolidation center has the same fixed cost as before (which is
questionable, given the increase in volume), the new approach saves $507,155 per year.

3. What should be done based on your analytics analysis? What have you not considered that
may make your analysis invalid or that may strategically limit success? What do you think
Grainger management should do?

Answer
Consolidating the 20’ volume and using a single consolidation center looks very attractive,
based on this analysis. However, there are other issues to be considered.

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GSMC520 Unit 6 Learning Activity
Solutions
 For one, we have not considered the increased cost to the suppliers that currently
pack their own 20’ containers. These suppliers will need to bear the cost of shipping
their goods to the Shanghai-Ningbo consolidation center. This cost will probably be
pushed back to Grainger in the long run.
 There will also be some added cost for the suppliers that currently ship to
consolidation centers directly. These will all need to use the Shanghai-Ningbo center
now, which might not be as close as their current consolidation center.
 The cost calculations also assume that the Shanghai-Ningbo center can handle the
increased workload and the fixed cost will remain the same. Neither of these
assumptions is guaranteed (or even likely).

We may want to seriously consider using two consolidation centers, with the other being in
Yantian–Hong Kong. It may be attractive to have consolidation centers in both Shanghai-
Ningbo and Yantian–Hong Kong because these are the most heavily used ports.
Assumptions regarding the consolidation center fixed costs would need to be tested as well.

Activity 3: CO 4, Competencies A and B

Chapter 11 (pp. 386–393): Review and Discussion Questions 1–9 and Problems 1, 8, 17, 20,
and 31

Review and Discussion Questions 1–9

1. Distinguish between dependent and independent demand in a McDonald’s, an integrated
manufacturer of personal copiers, and a pharmaceutical supply house.

Answer
The key to the answer here is to consider what must be forecasted (independent demand),
and, given the forecast, what demands are thereby created for items to meet the forecasts
(dependent demand).

In a McDonald’s, independent demand is the demand for various items offered for sale—Big
Macs, fries, and so on. The demand for Egg McMuffins, for example, needs to be forecasted.
Given the forecast, then, the demand for eggs, cheese, Canadian bacon, muffins, and
containers can then be computed based on the amount needed for each Egg McMuffin.

The manufacturer of copiers is integrated (i.e., the parts, components, etc. are produced
internally). The demand for the number of copiers is independent (must be forecasted).

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GSMC520 Unit 6 Learning Activity
Solutions
Given the forecast, the bill of materials is exploded to determine the amounts of raw
materials, components, parts, and so on that are needed (more on the BOM in Chapter 16).
The pharmaceutical supply company is an extreme case where only end items are carried
and nothing is produced internally. The bill of materials is the end item, and therefore, the
independent demand (forecasted from customers) is the same as the dependent demand.
One might attempt to consider that when the demand for items occurs together, this is
similar to a bill of materials. But this is not a bill of materials, but rather a causal relationship
making it easier to forecast.

2. Distinguish among in-process inventory, safety stock inventory, and seasonal inventory.
Answer
In-process inventory consists of those items of material components and partially
completed units that are currently in the production process.

Safety-stock inventory is set so that inventory is maintained to satisfy some maximum level
of demand. It could be stated that safety stock is that level of inventory between the
minimum expected demand and the desired level of demand satisfaction.

Seasonal inventory is that inventory accumulated to meet some periodic increase in

demand.

3. Discuss the nature of the costs that affect inventory size.

Answer
There are three main categories of costs: purchase cost, ordering costs, and holding costs.
The purchase cost may affect inventory levels if quantity discounts are offered. Suppliers
will offer a discount for placing larger orders, which might provide an incentive for carrying
the resultant larger inventory levels. Ordering costs directly influence the optimum order
quantity. As ordering costs increase, the effect is to order less often but in higher quantities,
thus increasing inventory levels. Holding costs have an inverse effect on inventory levels. As
holding costs increase, there is an incentive to reduce order quantities, resulting in lower
average inventory levels.
1. How does shrinkage (stolen stock) contribute to the cost of carrying inventory? How
can this cost be reduced?
Stock cannot be stolen unless it is on hand, and it is reasonable to assume that
shrinkage will increase as on-hand inventory levels increase. Shrinkage costs can be
reduced through increased security measures (security-related workforce, electronic
tracking tags) and/or reducing the amount of inventory on hand at any one point in
time.

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GSMC520 Unit 6 Learning Activity
Solutions
2. How does obsolescence contribute to the cost of carrying inventory? How can this
cost be reduced?
Obsolescence costs are relevant primarily in hi-tech industries. As inventory ages,
market influences and advancements in technology drive the value of that inventory
lower. The cost of making the item in inventory has likely decreased, and the latest
and greatest innovation lowers the value of the older technology. Obsolescence
costs can be reduced by producing in smaller quantities as the product matures. But
that will increase total setup costs.

4. Under what conditions would a plant manager elect to use a fixed–order quantity model as
opposed to a fixed–time period model? What are the disadvantages of using a fixed time–
period ordering system?

Answer
Fixed–order quantity models: when holding costs are high (usually expensive items or high
deprecation rates) or when items are ordered from different sources

Fixed–time period models: when holding costs are low (i.e., associated with low-cost items,
low-cost storage) or when several items are ordered from the same source (saves on order
placement and delivery charges)

The main disadvantage of a fixed–time period inventory system is that inventory levels must
be higher to offer the same protection against stockout as a fixed–order quantity system. It
also requires a periodic count and closer surveillance than a fixed–order quantity system. A
fixed–order quantity system can operate with a perpetual count (keeping a running log of
every time a unit is withdrawn or replaced) or through a simple two-bin or flag arrangement
wherein a reorder is placed when the safety stock is reached. This latter method requires
very little attention.

5. What two basic questions must be answered by an inventory-control decision rule?

Answer
Any inventory-control model or rule must establish (1) when items should be ordered and
(2) how many should be ordered.

6. Discuss the assumptions that are inherent in production setup cost, ordering cost, and
carrying cost. How valid are they?

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GSMC520 Unit 6 Learning Activity
Solutions
Answer
Investigation of ordering and production setup cost will likely show that a single, unique
cost does not exist for each product, nor is it linearly related to the number of orders (as
implied in the equations or inventory models). In the purchasing department, for example,
an employee is paid either a salary or an hourly rate for a normal work week. The cost for
that employee is sometimes divided among the number of items or orders for which he or
she has responsibility, resulting in an averaged or allocated cost for each order he or she
places. However, when we consider an inventory ordering cost based on the number or
orders per year (as is done in most inventory models), reducing the number of orders the
individual places does not necessarily decrease the net cost to the firm because his or her
weekly pay remains the same. What happens is really an increase in the ordering cost for
each of the remaining items within his or her responsibility.

Nonlinearity of costs also occurs in production setups. Consider the time for making a setup
in preparation for a production run. Setup time is roughly based on an expected frequency
of making this particular product run. However, as the frequency increases, familiarity with
the setup allows some shaving of the setup time. Moreover, if the setup is repeated often,
an investment in specialized equipment or the construction of jigs may become warranted,
reducing the setup time even more.

The terms carrying or holding costs for maintaining goods in inventory include a multitude
of cost elements. To determine the nature and amounts of these costs can be a challenging
feat. Fortunately, total inventory cost curves tend to be dish shaped and can, therefore,
tolerate some error. The holding costs associated with insurance, obsolescence, and
personnel who are handling materials are extremely difficult to ascertain on an item-by-
item basis, yet each requires realistic analysis. Warehouse storage costs of an item, for
example, may be based on a ratio of its required square footage and the entire available
warehouse space, but this may not be an accurate representation because it is an allocation
of cost rather than true cost. Take a warehouse that is too large or is used to stock products
in an off season or depressed period. Allocation based on a share of total warehouse cost
will result in a high cost for storage when excess storage space should actually create
pressure for higher—not lower—order quantities.

In the simple inventory model, holding costs are based on the average inventory on hand.
“Average” inventory presumes that, as stock is depleted, other product lines will be moved
in to occupy the space. It may be that costs should be based on maximum inventory,
especially if these is an excess of space, or if the needs of an item are so specialized that no
other products can use the space (for example, due to environmental requirements). Each
remaining cost may be similarly challenged. Breakage, pilferage, deterioration, and

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GSMC520 Unit 6 Learning Activity
Solutions
insurance costs are not constant, but vary with inventory size. As the value of inventory
increases, insurance rates decrease, more refined handling procedures can be installed to
reduce breakage, some environmental control and maintenance can be used to reduce
deterioration, and better security procedures can reduce theft.

These challenges to determining true costs are not intended to discourage the use of
inventory models. The intent, rather, is to prevent the use of any model without clear
knowledge of its requirements and assumptions. Indeed, each application must consider
the operating conditions and needs of the firm. An appropriate model can then be
developed in a fashion similar to those covered in this chapter.

7. “The nice thing about inventory models is that you can pull one off the shelf and apply it so
long as your cost estimates are accurate.” Comment on this.

Answer
Unfortunately, there is no model or set of models universally applicable to all inventory
situations. As stated in the chapter several times, each situation is different and requires a
model to suit those conditions. Students frequently try to memorize specific models rather
than the process of building any inventory model. See also the answers to Question 8
below.

8. Which type of inventory system would you use in the following situations?

Answer
a. Supplying your kitchen with fresh food
b. Obtaining a daily newspaper
c. Buying gas for your car
To which of these items do you impute the highest stockout cost?

(a) Supplying kitchen with food: This is both a periodic model and order quantity. Generally,
a household will shop once weekly for the majority of items (periodic), then pick up
items such as bread and milk as the supply runs low (fixed quantity with reorder point).

(b) Obtaining a daily newspaper: A daily newspaper is obviously a periodic model. One does
not usually wait until he has finished one daily paper before buying the next day’s
paper.

(c) Buying gas for your car: Generally, this is a hybrid-type model wherein a reorder point is
signaled when the gas indicator is low, and then the tank is filled. Many people,
however, have a fixed quantity purchase when the reorder point is reached, such as

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Page | 15
GSMC520 Unit 6 Learning Activity
Solutions
“put in 10 gallons or $10.00 worth.” Still others (drawing upon their own experience)
use a periodic ordering system on their spouse’s car, such as taking it out and filling it
every Sunday after church (or in Chase’s case, after the football game).

The highest stockout cost for most well-fed, well-read individuals would be running out of
gas in your car. The cost could range from practically zero (if one runs out in front of a gas
station) to being late for an appointment or causing an accident on the highway.

9. What is the purpose of classifying items into groups, as the ABC classification does?

Answer
Using a classification scheme such as this one allows a greater portion of time to be spent in
controlling specific groups, classes, or items. For the ABC grouping, greater control is
afforded those items that comprise the greatest dollar volume in usage. The result of this
classification is a reduction in the overall inventory size, leading to decreased costs for the
same level of satisfying inventory demands.

Problems 1, 8, 17, 20, and 31

Answers
1. Cu = $10 - $4 = $6
Co = $4 - $1.50 = $2.50

Cu 6
P≤ = =.7059
C o +C u 2. 50+6 , NORMSINV(.7059) = 0.541446

Should purchase 250 + .541446(34) = 268.4 or 268 boxes of lettuce.

8.

Qopt =
√ √
2 DS 2(1000 )25
H
=
100 = 22.36 → 22

17.

a.
Qopt =
√ √
2 DS 2(2000 )10
H
=
5 = 89.44 → 89

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Page | 16
GSMC520 Unit 6 Learning Activity
Solutions
D 2000
S= (10 )
b. Ordering cost = Q 89 = $224.72

Q 89
H= (5 )
c. Holding cost = 2 2 = $222.50

20. a.
Qopt =
√ √
2 DS 2(5000 )10
H
=
.20(3 ) = 408.25 → 408 bottles

b.
σ L= √ Lσ 2 =√ 3(30)2 = 52 units

95% S.L.  from standard normal distribution, z = 1.64

R=d L+zσ L = 100(3) + (1.64)52 = 300.00 + 85.28 = 385.28 → 385 bottles

31.
Item Average Price per Monthly Class
Number Monthly Unit Usage
Demand
5 4,000 21 84,000 A
3 2,000 12 24,000 A or B
4 1,100 20 22,000 B
7 3,000 2 6,000 B
9 500 10 5,000 B
1 700 6 4,200 B or C
8 2,500 1 2,500 C
10 1,000 2 2,000 C
6 100 10 1,000 C
2 200 4 800 C

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Page | 17
GSMC520 Unit 6 Learning Activity
Solutions
Activity 4: CO 4, Competency C
Chapter 11 (pp. 395–398): Analytics Exercise: Inventory Management at Big10 Sweaters.com

1. You are curious about how much Rhonda and Steve made with their business last year. You
do not have all the data, but you know that most of their expenses relate to buying the
sweaters and having them monogrammed. You know they paid themselves $50,000 each
and you know the rent, utilities, insurance, and benefit package for the business were about
$20,000. About how much do you think they made before taxes last year? If they must
make their payment to the venture capital firm, and then pay 50% in taxes, what was their
increase in cash last year?

Answer

Last Year’s Pretax Profit

Unit Unit
Sales Sale Price Cost Revenue Cost Margin
Ohio 2,300 $120 73.88 $276,000 $169,924 $106,076
Michiga
n 1,468 $120 73.88 $176,160 $108,456 $67,704
Purdue 890 $120 73.88 $106,800 $65,753 $41,047
eBay 342 $50 60.88 $17,100 $20,821 ($3,721)
Totals 5,000 $576,060 $364,954 $211,106
Overhead: $120,000
Net
Profit: $91,106

If they pay 25% to the venture capital firm, this is $22,776.50, and their profit before taxes
is $68,329.50. They then pay $34,164.75 in taxes, leaving them with an increase in cash of
about $34,165. The major point here is to show how relevant these decisions are to the
success of the firm.

2. What was your reasoning behind using the aggregate demand forecast when determining
the size of your order rather than the individual school forecasts? Should you rethink this or
is there a sound basis for doing it this way?

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Page | 18
GSMC520 Unit 6 Learning Activity
Solutions
Answer
Here we argue that the aggregate forecast should be more accurate than the individual
person’s forecast. You can easily calculate the coefficient of variation (CV) in the individual
forecasts and compare that to the aggregate forecast to prove this (the CV for the individual
forecasts is between 10% and 14%, and the CV for the aggregate forecast is less than 6%). A
big assumption here is that the forecasts at each school are independent and that they are
not biased. If this is true, the errors will tend to cancel each other out. If there is major bias
in the forecasts (for example, they are all high or low), then we have a problem and it might
be better to use the individual forecasts. In our analysis here, we assume the forecasts are
independent and not biased but we also calculate the orders by individual school.

3. How many sweaters should you order next year? Break down your order by individual
school. Document your calculations in your spreadsheet. Calculate this based on the
aggregate forecast and also the forecast by individual school.

Answer
Here the single-period model is applicable. The cost of underestimating demand is the lost
profit. In this case, a sweater would be sold for $120 and it would cost $73.88 (supplier plus
subcontractor cost), so the return is $46.12 per sweater. The cost of overestimating
demand is the difference between the supplier cost of $60.88 and the eBay price of $50,
which is $10.88.

The critical probability then is Cu / (Co + Cu) = 46.12 / (10.88 + 46.12) = .809123.

Using the aggregate demand forecast, which has a mean of 7,400 and standard deviation of
430 units, you should order NORMINV(.809123,7400,420) = 7,776 units. Based on the
forecast data, Ohio State gets 33.78% or 2,627 units, Michigan get 23.87% or 1,856 units,
Purdue get 13.51% or 1,051 units, Michigan State gets 21.85% or 1,699 units, and Indiana
gets 6.98% or 543 units.

If we base this on the individual forecasts, we would order the following.

Ohio State = NORMINV(.809123,2500,300) = 2,762
Michigan = NORMINV(.809123,1767,252) = 1,987
Purdue = NORMINV(.809123,1000,100) = 1,087
Michigan State = NORMINV(.809123,1617,126) = 1,727
Indiana = NORMINV(.809123,517,76) = 583

The total order size would be 8,146. There is a difference of 8,146 - 7,767 = 379 sweaters.

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Page | 19
GSMC520 Unit 6 Learning Activity
Solutions

4. What do you think they could make this year? They are paying you $40,000 and you expect
your benefit package addition would be about $1,000 per year. Assume that they order
based on the aggregate forecast.

Answer
We base this on the expected average sales from our forecast and an aggregate order size
of 7,767 sweaters. Assuming sales are as forecast, the safety stock would be sold on eBay.
We also need to adjust overhead to account for the $41,000 increase due to the new
employee.

This Year’s Expected Pretax Profit

Unit Unit
Sales Sale Price Cost Revenue Cost Margin
Ohio 2,500 $120 73.88 $300,000 $184,700 $115,300
Michigan 1,767 $120 73.88 $212,040 $130,546 $81,494
Purdue 1000 $120 73.88 $120,000 $73,880 $46,120
Michigan
State 1617 $120 73.88 $194,040 $119,464 $74,576
Indiana 517 $120 73.88 $62,040 $38,196 $23,844
eBay 366 $50 60.88 $18,300 $22,282 ($3,982)
Totals 7,767 $906,420 $569,068 $337,352
Overhead: $161,000
Net Profit: $176,352

Using the same logic as before, the venture capital people get $44,088, leaving us with
$132,264 to pay taxes on. Taxes would be $66,132. This creates an increase in our cash of
about $66,132.

5. How should the business be developed in the future? Be specific and consider changes
related to your supplier, the monogramming subcontractor, target customers, and
products.

Answer
This is open ended, so you may get many different ideas. Here you can begin the discussion
by talking about the core competencies of this firm. Actually, this firm does not have much
that could not be quickly duplicated. It has its website, a marketing channel through the

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Page | 20
GSMC520 Unit 6 Learning Activity
Solutions
game programs, and the unique design of its monogram. So in developing the business, it
should think about ways it could make better use of these capabilities and assets. Here are
some thoughts.

Supplier: Here it would be good to try to reduce cost, reduce the minimum order quantity,
and reduce the lead time associated with the order. Any of these would be desirable. If it
were possible to reduce the minimum order quantity and the lead time, then multiple
orders could be placed during the season instead of a single order. For example, one order
could cover the initial half of the season and a second could cover the rest. This should
allow for more accurate forecasts and less product sold through eBay. They might consider
using a domestic (U.S.) supplier or possibly even consider subcontracting the sweater
making to locals. A quick web search shows that automated machines at fairly low cost are
now available.

Monogramming subcontractor: They might consider doing this in-house. They have a pretty
good deal right now, though, because the subcontractor is providing space for inventory
and shipping the product to the customer.

Target customers: They could expand this to the rest of the Big Ten teams. Other sports,
particularly international venues, such as soccer could be developed.

Products: Many similar products that would be personalized could be developed, such as
sweatshirts, jackets, blankets, and blazers. These would possibly use the same or similar
suppliers, and have the same requirements related to monogramming. Getting into totally
different kinds of products, such as coolers, might be another idea. It’s probably important
to try to exploit the idea of high-end products that are attractive as gifts.

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