IE CERTIFICATION

REVIEW: PRODUCTION
PLANNING AND
CONTROL (PART 1)
PREPARED: ENGR. GILBERT M. CALOSA, MSIE, CIE, AAE
 Forecasting

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 ➢ Forecasts are the basis for budgeting and planning for
capacity, sales, production and inventory, personnel,
purchasing, and more.
➢ Forecasts play an important role in the planning process
because they enable managers to anticipate the future
so they can plan accordingly.
➢ Forecasts affect decisions and activities throughout an
organization, in accounting, finance, human resources,
marketing, MIS, as well as operations, and other parts of
an organization.
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 Two General Approaches to Forecasting:

1. Qualitative methods consist mainly of subjective

inputs, which often defy precise numerical description.
2. Quantitative methods involve either the extension of
historical data or the development of associative
models that attempt to utilize causal (explanatory)
variables to make a forecast.

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Qualitative Method
➢ Forecasts Based on Judgment and Opinion
1. Executive Opinions
2. Salesforce Opinions
3. Consumer Surveys
4. Delphi Method - involves circulating a series of
questionnaires among individuals who possess the
knowledge and ability to contribute meaningfully.

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
➢ Time Series Models

1. Naive Forecast
- the forecast for any period equals the previous
period's actual value.
- a simple, but widely used approach to forecasting

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
➢ Time Series Models
2. Moving Average
- Technique that averages a number of recent actual values,
updated as new values become available.

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
Moving Average Example:
From the records of delivery orders, management has
accumulated the following data for the past 10 months. Compute a 3-
month moving average forecast.

a. 900 c. 1100
b. 1300 d. 3300

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
➢ Time Series Models
3. Weighted Moving Average
- A weighted average is similar to a moving average, except
that it assigns more weight to the most recent values in a
time series.

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
Weighted Moving Average Example:
In reference to previous problem, the company wants to
compute a 3-month weighted moving average with a weight of
50 percent for the October data, a weight of 33 percent for the
September data, and a weight of 17 percent for the August data.
These weights reflect the company’s desire to have the most
data influence the forecast most strongly.

a. 345 c. 450
b. 1,034 d. 1,045
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 Quantitative Method
➢ Time Series Models
4. Exponential Smoothing
- Each new forecast is based on the previous forecast
plus a percentage of the difference between the forecast
and the actual value of the series at that point.

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
4. Exponential Smoothing

New forecast = Last period’s forecast + a (Last period’s actual

demand – Last period’s forecast)

Ft = Ft – 1 + a(At – 1 - Ft – 1)
where: Ft = new forecast
Ft – 1 = previous forecast
a = smoothing (or weighting) constant
(0 ≤ a ≤ 1) 12
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 Quantitative Method
Exponential Smoothing Example: The company has accumulated
the demand data in the table below for its computers for the past
twelve months, from which it wants to consider exponential
smoothing forecasts using smoothing constant equal to 0.30.

a. 50.84 c. 51.79
b. 54.31 d. 56

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
Exponential Smoothing Solution:

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
➢ Adjustment with Trend

1. Trend-Adjusted Exponential Smoothing

- Variation of exponential smoothing used when a time
series exhibits trend.

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
Trend-Adjusted Exponential Smoothing
Ft = a(At - 1) + (1 - a)(Ft - 1 + Tt - 1)
Tt = b(Ft - Ft - 1) + (1 - b)Tt - 1
where
T = an exponentially smoothed trend factor
b = a smoothing constant for trend

Step 1: Compute Ft
Step 2: Compute Tt
Step 3: Calculate the forecast AFt = Ft + Tt
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 Quantitative Method
Trend-Adjusted Exponential Smoothing Example:
Compute for the 4th month forecast using the exponentially
smoothed forecast with constant = 0.20 and with a
smoothing constant for trend of 0.40.

a. 18.4 c. 20.14
b. 15.65 d. 22.12
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 Quantitative Method
➢ Adjustment with Trend
2. Linear Trend

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
➢ Adjustment with Trend
2. Linear Trend

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
➢ Adjustment with Trend
Correlation

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
Linear Trend Example:
In reference to example in exponential smoothing, the
demand data for computers appears to follow an increasing
linear trend. The company wants to compute a linear trend
line to see if it is more accurate than exponential
smoothing. What is the forecast on period 13?

a. 52 c. 54
b. 56 d. 58

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
➢ Adjustment with Trend

Seasonal Index

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
Seasonal Index Example:
Marcus Farms grows chickens to sell to a meat processing
company throughout the year. However, its peak season is
obviously during the fourth quarter of the year, from October
to December. Marcus Farms has experienced the demand for
chickens for the past three years shown in the following table:

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantitative Method
Seasonal Index Example:

What are the seasonally adjusted forecast per quarter in year

2012?
a. 12, 8, 7, 18 c. 14, 10, 8, 20
b. 16, 12, 9, 22 d. 18, 14, 10, 20

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Forecast Accuracy

➢ Forecast Accuracy – based on historical error

performance of a forecast.

➢ Forecast error - the difference between the value that

occurs and the value that was predicted for a given time
period.
Error = Actual - Forecast

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Two Common Measures of Error

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Forecast Accuracy
MAD and MSE Example:
Compute the MAD and MSE for the following data.

a. 2.57; 10.68 c. 7.25; 18.6

b. 2.75; 10.86 d. 5.27; 16.8
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 Inventory Management

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Inventory – refers to stock or store of goods.

Types of Inventories:
➢Raw materials and purchased parts
➢Work in process (WIP)
➢Finished good inventories
➢Replacement parts, tools, and supplies

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Functions of Inventories:
• To meet anticipated demand
• To smooth production requirements
• To protect against stock outs
• To hedge against price increases
• To take advantage of quantity discounts

Inventory Control - refers to the systematic location, storage, and

recording of goods in such a way that desired degree of service
may be rendered at minimum cost.
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 Objectives of Inventory Control:
• Maximize level of customer service
• Minimize costs (carrying costs and ordering costs)

Types of Demand:
➢ Independent demand items - finished goods or other end
items that are sold to customers
➢ Dependent demand items - subassemblies or component
parts that will be used in the production of a final or finished
product

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Inventory Costs:
➢ Purchasing cost - is the price per unit of an inventory item. At
times the item is offered at a discount if the order size exceeds
a certain amount, which is a factor in deciding how much to
order.
➢ Ordering cost - the cost associated with ordering inventory.
- also known as preparation cost or setup cost
- it includes costs of preparing the paperwork for purchase
orders, communication costs(telephone, fax, etc.),
handling the delivery of the shipment, unpacking the
ordered items after the shipment arrives, inspecting, and
moving items into storage, etc.
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 Inventory Costs:
➢ Carrying cost - costs associated with carrying inventory.
- also known as holding cost
- it includes cost of capital(dividends or interest on funds invested
in inventory or the opportunity cost if the company does not borrow
money), cost of storage(warehouse related costs), obsolescence
cost(when the items in inventory become outdated they lose value),
insurance and taxes on inventory.
➢ The shortage cost (sometimes called the unsatisfied demand
cost) is incurred when the amount of the commodity required
(demand) exceeds the available stock. This cost depends upon
which of the following two cases applies.
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 Two fundamental decisions in Inventory Management:

• The timing of order (when to order)

• The size of an order (how many to order)

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 The Inventory Cycle

Q = 350 units (Qty on Hand) Usage rate = 50 units per day

Reorder Point = 100 units

Place order Receive order

Lead Time = 2 days

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 How Many to Order:
The Economic Order Quantity
The economic order quantity (EOQ) model is used to determine
an order quantity that minimizes the sum of ordering and carrying
costs. The basic EOQ model makes the following assumptions:

• Annual demand is known

• Demand is even
• Lead time is constant
• No quantity discounts
• Only one product is involved
• Orders are received in single deliveries
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 How Many to Order:
The Economic Order Quantity
• These assumptions allow us to use a simple calculation for total costs
related to the quantity we order.

Total Cost = Annual Carrying Cost + Annual Ordering Cost

TC = H(Q/2) + S(D/Q)
Where:
TC = Total cost
H = Carrying or holding cost per unit, on an annual basis
Q = Order quantity
S = Cost of ordering
D = Annual demand
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE 11-37
 How Many to Order:
The Economic Order Quantity
• The relationships among the ordering cost, carrying costs, and total
cost curve:

Ordering at this quantity will

minimize the total costs

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE 11-38
 How Many to Order:
The Economic Order Quantity

The EOQ Formula:

2DS
Q opt = = EOQ
H

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 How Many to Order:
The Economic Order Quantity
EOQ Example:
A local distributor for a national tire company expects to
sell 9, 600 steel belted radial tires of a certain size and
trade design next year. Annual carrying cost is P 16 per
tire, and ordering cost is P 75. The distributor operates
288 days a year. What is the optimal order size?

a. 300 c. 450
b. 350 d. 320

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 How Many to Order:
The Economic Order Quantity
EOQ Example:

From the previous problem, how many times per year

does the store reorder?

a. 23 c. 34
b. 32 d. 42

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 How Many to Order:
The Economic Order Quantity
EOQ Example:

From the previous problem, what is the length of an

order cycle?

a. 12 days c. 9 days
b. 14 days d. 16 days

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 How Many to Order:
The Economic Order Quantity
EOQ Example:

From the previous problem, what is the total annual cost if

the EOQ quantity is ordered?

a. P 4,800 c. P 2,400
b. P 2,800 d. P 5,200

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 How Many to Produce:
The Economic Production Quantity
➢ If an item is purchased, the critical question is:
"How much should we order each time?" and the
answer is given by Economic Order Quantity(EOQ).

➢ If an item is manufactured the question becomes

"How much should we produce each time?" and
the answer is given Economic Production Quantity
(EPQ).

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 How Many to Produce:
The Economic Production Quantity
The EPQ model makes the following assumptions:

➢ Annual demand is known

➢ Lead time is constant
➢ No quantity discounts
➢ Only one item is involved
➢ The usage rate is constant
➢ Usage occurs continually, but production occurs
periodically
➢ The production rate is constant
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 How Many to Produce:
The Economic Production Quantity
The EPQ Formula:

2DS
EPQ =
d
H(1− )
p
Where:
H = Carrying or holding cost per unit, on an annual
basis
S = Set up Cost
D = Annual demand
d = usage rate/demand rate
p = production rate
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 How Many to Produce:
The Economic Production Quantity
Imax = Q(1−d/p)

Total Cost = Annual Carrying Cost + Annual Setup Cost

QH d DS
TC = x 1− +
2 p Q

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 How Many to Produce:
The Economic Production Quantity
EPQ Example:
A toy manufacturer uses 48,000 rubber wheels per year
for its popular dump truck series. The firm makes its own
wheels, which it can produce at a rate of 800 per day. The toy
trucks are assembled uniformly over the entire year. Carrying
cost is $ 1 per wheel a year. Set up cost for a production run of
wheels is $ 45. The firm operates 240 days per year. Determine
the optimal run size

a. 1200 c. 4800
b. 3600 d. 2400
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 How Many to Produce:
The Economic Production Quantity
EPQ Example:
From the previous problem, determine the minimum
total annual cost for carrying and set up.

a. P 1,800 c. P 3,400
b. P 2,800 d. P 4,200

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantity Discount Model
Quantity Discounts – are price reductions for large orders
offered to customers to induce them to buy in large
quantity.

Total Cost = Carrying Cost + Ordering Cost + Purchasing Cost

TC = H(Q/2) + S(D/Q) + PD
Where: P = unit price, D= Annual Demand

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Quantity Discount Model
Procedures for Computing the Overall EOQ:

1. Compute the common minimum point.

2. Only one of the unit prices will have the minimum in its feasible range
since the ranges do not overlap. Identify that range.

a. If the feasible minimum point is on the lowest price range, that is the
optimal order quantity.

b. If the feasible minimum point is in any other range, compute the total cost
for the minimum point and for the price breaks of all lower unit costs.
Compare the total costs; the quantity (minimum point or price breaks) that
yields the lowest total cost is the optimal order quanity.
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 Quantity Discount Example:
The maintenance department of a large hospital uses about 816
cases of liquid cleanser annually. Ordering costs are $12,
carrying costs are $4 per case a year, and the new price schedule
that orders of less than 50 cases will cost $20 per case, 50 to 79
cases will cost $18 per case, 80 to 99 cases will cost $17 per case
and larger orders will cost $16 per case. Determine the optimal
order quantity and the total costs.

a. 70 cases at $13,354 c. 70 cases at $14,968

b. 100 cases at $13,354 d. 80 cases at $14,154
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 When to Order: The Reorder Point
Reorder Point (ROP) - When the quantity on hand of an item
drops to this amount, it is time to reorder.

Four Determinants of the ROP Quantity:

 rate of demand
 lead time
 extent of demand and/or lead time variability
 degree of stock out risk acceptable to management

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 When to Order: The Reorder Point
ROP for Constant Demand and Lead time:

ROP = demand rate x lead time

ROP = d X LT

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 Basic ROP Example:
Mr. X takes two vitamins a day, which are delivered to
his home by a route men seven days after an order is
called in. At what point should Mr. X reorder?

a. 14 c. 24
b. 12 d. 7

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 ROP when variability is present
➢ Safety stock - additional inventory maintained to increase
service levels in response to demand variability.
➢ Stock out risk – the risk of running out of inventory during lead
time.
➢ Service level – the probability that demand will not exceed
supply during lead time.
Service level = 100% - stock out risk
➢ ROP when variability is present:
ROP = (demand rate x lead time) + safety stock
ROP = (d X LT) + SS

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 ROP when variability is present

The amount of safety stock that is appropriate for a

given situation depends on the following:

• The average demand rate and average lead time

• Demand and lead time variability
• The desired service level

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 ROP when variability is present
Z-value for Commonly used Service Level:

Service Level Z-value

90% 1.28
95% 1.645
97% 1.88
98% 2.00
99% 2.33

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 ROP when variability is present
ROP when only the demand is variable:
ROP = d x LT + [ z LT (d) ]
ROP when only the lead time is variable:
ROP = d x LT + [ z d (LT) ]

ROP when both the demand and lead time are variable:

ROP = d x LT + [ z LT x 2d + (d2 x 2LT ) ]

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 ROP when variability is present
Example:
A restaurant uses an average of 50 jars of a special sauce each
week. Weekly usage of sauce has a standard deviation of 3
jars. The manager is willing to accept no more than 10% risk
of stock out during lead time which is two weeks. Assume the
distribution of usage is normal. Determine the ROP.

a. 122 c. 106
b. 116 d. 112

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 ROP when variability is present
Example:
Consumption of beverage at local store is known to be
normally distributed with a mean of 100 bottles per day
and a standard deviation of 8 bottles per day. Delivery time
is normally distributed with a mean of five days and
standard deviation of one day. How many bottles should be
on hand at ROP time in order to be 90% sure of not running
out before delivery arrives?

a. 635 c. 365
b. 630 d. 420
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE
 ABC Analysis
ABC Analysis
- (or Selective Inventory Control) is an inventory categorization
technique. ABC analysis divides an inventory into three
categories- "A items" with very tight control and accurate
records, "B items" with less tightly controlled and good records,
and "C items" with the simplest controls possible and minimal
records.

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 ABC Analysis
➢ Divides inventory into three classes based on annual dollar
volume
▪ Class A - high annual dollar volume
▪ Class B - medium annual dollar volume
▪ Class C - low annual dollar volume
➢ Used to establish policies that focus on the few critical
parts and not the many trivial ones

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 ABC Analysis
ABC classes are:
➢‘A’ items – 70% - 80% of the annual consumption
value of the items.
➢‘B’ items – 15% - 25% of the annual consumption
value of the items.
➢‘C’ items - 5% of the annual consumption value of
the items.

IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE

 ABC Analysis
Example: Considering the data illustrated in table below, perform an ABC
analysis. Which item is included in class B?
Stock Number Annual $
Volume
J24 12,500
R26 9,000
L02 3,200
M12 1,550
P33 620
T72 65
S67 53
Q47 32
V20 30
a. R26 c. Q47
b. P33 d. M12
IE Certification Review: PPC by Engr. Gilbert M. Calosa, MSIE, CIE, AAE