IE 5329: Production and Inventory Control Systems

Problem Set #1: Deterministic Inventory Control Problems

1. Nebraska Furniture Mart sells 5,500 chairs of a particular style each year. The chairs are purchased
from the factory at a cost of $45. The accounting department has estimated the annual inventory
carrying cost rate to be 0.4. Labor, mail, and receiving costs per order are estimated at $125.
Determine the optimal order quantity for Nebraska Furniture Mart.

2. The service department at Mellow Johnny’s Bike Shop installs 225 new derailleurs per year, all of
which are purchased from a single local supplier at a cost of $18.50 each. The shop uses a holding
cost based on a 25% annual interest rate. The shipping cost for an order for derailleurs, regardless of
the order size, is $28.

a. Determine the optimal number of derailleurs the shop should purchase each time an order
is placed, and the time between placement of orders.

b. If the replenishment lead time is six weeks, what is the reorder point based on the level of
on-hand inventory?

c. The current reorder policy is to buy derailleurs only once a year. What is the additional cost
incurred by this policy?

3. A distribution center stocks three items, for which it has 6,000 square feet of storage space
available. Using the data in the table below, find the optimal order quantities.

Item Annual Demand Order Cost Unit Holding Cost Square feet/unit
1 12,500 $150 $2.40 5.00
2 15,000 $80 $3.50 4.00
3 15,000 $80 $3.00 4.00

4. A factory purchases 150,000 small sheet metal enclosures per year. The fixed ordering cost is $60.
The unit cost is $0.25 if ordered in quantities less than 1,000, $0.24 if the order size is between
1,000 and 10,000, and $0.23 for orders of more than 10,000. The annual holding cost rate is 0.4.
Find the optimal order quantity and the total average annual inventory cost.
5. A specialty coffeehouse sells Colombian coffee at a fairly steady rate of 280 pounds
annually. The beans are purchased from a local supplier for $2.40 per pound. The
coffeehouse estimates that it costs $45 in paperwork and labor to place an order for the
coffee, and holding costs are based on a 20 percent annual interest rate.

a. Determine the optimal order quantity for Colombian coffee.

b. What is the time between placement of orders?
c. What is the average annual cost of holding and setup due to this item?
d. If replenishment lead time is three weeks, determine the reorder level based on the on-
hand inventory.

6. Consider the coffeehouse discussed in Problem 5. Suppose that its setup cost for ordering
was really only $15. Determine the error made in calculating the annual cost of holding and
setup incurred as a result of using the wrong value of A. (Note that this implies that its current
order policy is suboptimal.)

7. The owner of a local hardware store is assessing his inventory policy for hammers. The store sells an
average of 50 hammers per month, so the owner has been placing an order to purchase 50
hammers from a wholesaler at a cost of $20 per hammer at the end of each month. The manager
does all of the ordering for the store himself, and it is taking a great deal of his time. He estimates
that the value of his time spent in placing each order for hammers is $75.
a. What would the unit holding cost for hammers need to be for the owner’s current inventory
policy to be optimal?

b. What is the total average annual inventory cost for the current inventory policy?

c. What is the unit holding cost found in part (a), as a percentage of the cost per unit?

d. What is the optimal order quantity if the unit holding cost is actually 20% of the cost per
unit?

e. What is the total average annual inventory cost for the optimal policy found in part (d)?

8. Using the basic EOQ model, determine how Q* would change for each of the following changes to
the costs or the demand rate.
a. The ordering cost is reduced to 25% of its original value.

b. The annual demand rate becomes four times as large as its original value.

c. Both changes in parts (a) and (b).

d. The unit holding cost is reduced to 25% of its original value.

e. Both changes in parts (a) and (d).

9. In the calculation of an optimal policy for an all-units discount schedule, you first compute
the EOQ values for each of the three order costs, and you obtain: Q(0) = 800, Q(1) = 875, and
Q(2) = 925. The all-units discount schedule has breakpoints at 750 and 900. Based on this
information only, can you determine what the optimal order quantity is? Explain your
answer.

10. You have recently begun working as an industrial engineer for John Deere. You learn from a buyer
in the procurement department that the company’s facility in Des Moines consumes 3,000 wheel
bolts each month. Furthermore, the buyer informs you that these bolts are currently being
replenished using an EOQ value of 2,000 bolts, which was computed assuming an annual interest
rate of 36%. The current purchase cost is $4.00 per bolt.

a. What is the ordering cost used to determine the EOQ value?

Now suppose that the buyer receives an offer from a new vendor, in which a discount of 5% would
be given if the company purchases the bolts in quantities of 3,000 or more.

b. Should the buyer accept the offer from the vendor? If so, how much money can be saved?

11. Holding cost can be difficult to estimate. Suppose you discover an error in your original estimate of
holding cost, such that the actual cost is (a * h) for some constant a.

a. Using the basic EOQ model, derive an expression for the ratio of the true optimal batch size
(that is, Qopt) to that found by the model when using your incorrect estimate of h (Q*).

b. Now derive an expression for the ratio of the true total average annual relevant cost,
G(Qopt), to the incorrect relevant cost, G(Q*).

c. Plot the expression that you found in Part b as a varies from 0 to 2.

d. Is it better to overestimate or underestimate the holding cost? Explain.

12. An assembly plant purchases 35,000 air filters per year. Fixed ordering cost is $100. The company
uses an inventory holding cost rate of $0.40/filter/year. The vendor has offered the following price
schedule: For orders of 5,000 or more, the unit cost is $2.50. For orders of 1,000 to 4,999, the unit
cost is $2.65. Orders for fewer than 1,000 have a unit cost of $2.85. Find the optimal order
quantity.

13. A chemical company produces a thermoplastic resin that is used for injection molding. The resin can
be produced at a rate of 10,000 pounds per day. Annual demand for the resin is 0.60 million pounds
per year. The fixed cost of setting up for a production run of resin is $1,500, and the variable cost of
production is $4.00 per pound. The company uses an interest rate of 25% to account for holding
costs. Assume that there are 250 working days in a year.

a. What is the optimal size of the production run for this resin?

b. What are the total average annual costs of holding and setup attributed to the resin?
14. A manufacturer of greeting cards must determine the size of production runs for a certain popular
line of cards. The demand for these cards has been a fairly steady 2 million per year, and the
manufacturer is currently producing the cards in batch sizes of 50,000. The cost of setting up for
each production run is estimated to be $400. Assume that for each card the material cost is $0.35,
the labor cost is $0.15, and the distribution cost is $0.05. The annual interest rate that represents
the opportunity cost of alternative investment and storage is estimated as 20% of the value of each
card.

a. What is the optimal value of the EOQ for this line of greeting cards?

b. Determine the additional annual cost resulting from using the non-optimal production lot
size.

c. Suppose that the company decides to account for the fact that the production rate of the
cards is not infinite. Determine the optimal size of each production run, assuming that the
cards are produced at a rate of 75,000 per week (assume 52 weeks per year).

15. A buyer for a particular type of silicon wafer used in the production of semiconductors must
decide among three suppliers. Supplier A will sell the silicon wafers for $2.50 per wafer,
independently of the number of wafers ordered. Supplier B will sell the wafers for $2.40
each but will not consider an order for fewer than 3,000 wafers. Supplier C will sell the
wafers for $2.30 each but will not accept an order for fewer than 4,000 wafers. Assume an
ordering cost of $100, an annual requirement of 20,000 wafers, and a 20% annual interest
rate for holding cost calculations. Which supplier should be used, and what is the size of the
standing order with that supplier?

16. Avoca is a popular coffee shop on Magnolia Avenue in Fort Worth. To satisfy their health-
conscious customers, they have recently started selling bottles of fresh-pressed organic juice,
which they purchase from Clean Juice Company for $8 per bottle. Right now, Avoca’s
manager believes that the demand for the juice is at a reasonably steady rate of 10 bottles per
day. Each time she reorders from Clean Juice, she orders exactly 70 bottles. Clean Juice
delivers the bottles to Avoca exactly 2 days after receiving the replenishment order, and they
charge $15 to make a delivery. Avoca’s manager estimates that it costs $100 per year to hold
one bottle in inventory. Using this information, answer the questions below.

a. What value of Q is Avoca currently using to control inventory replenishment for the
juice?
b. What is the total average annual inventory cost associated with Avoca’s current
inventory control policy?
c. Suppose Avoca decides to adopt an EOQ inventory control policy instead. What
replenishment quantity will minimize total average annual inventory cost?
d. If the EOQ policy is followed, what is the optimal reorder point?
e. If the optimal EOQ policy is followed, what is the length of each inventory
replenishment cycle?
f. What is the total average annual inventory cost associated with the EOQ inventory
control policy?
17. (continued from problem 16 above) Avoca’s manager has recently discovered a new organic
juice supplier in Dallas called Buda Juice. Buda Juice offers discounted prices for bulk
orders according to the table below, and they will deliver an order to Avoca 2 days after
receiving the order. However, they charge a $20 fee per delivery to all Fort Worth locations
(including Avoca). What is Avoca’s optimal replenishment quantity if they purchase juice
from Buda Juice?

# Bottles per Order Price per Bottle

1-20 $8.00
21-40 $7.90
41-60 $7.80
Over 60 $7.70

18. (continued from problems 16 & 17 above) Which inventory control policy should Avoca
adopt: 1) their current replenishment strategy with Clean Juice, 2) the optimal EOQ
replenishment strategy with Clean Juice, or 3) the optimal replenishment policy with Buda
Juice? Justify your answer.

19. (continued from problems 16-18 above) Avoca’s manager is considering purchasing a juicing
machine to produce the juice in-house. She estimates that production cost, including
materials, labor, and machine expense, would be approximately $7.50 per bottle. Avoca’s
workers currently have the capacity to produce 20 bottles per day. Each production run
would require 1 hour of setup and clean-up by one worker who is paid $15 per hour.
Assuming the demand rate and unit holding cost rate stay the same, should Avoca produce
their own juice in-house? Justify your answer.