Inventory Management Practice Questions

Question 1

A large bakery buys flour in 25-pound bags. The bakery uses an average of 4,860 bags a
year. Preparing an order and receiving a shipment of flour involves a cost of $10 per
order. Annual carrying costs are $75 per bag.

a. Determine the economic order quantity.

b. What is the average number of bags on hand?
c. How many orders per year will there be?
d. Compute the total cost of ordering and carrying flour in a year.
e. If ordering costs were to increase by $1 per order, how much would that affect the
minimum total annual cost?

Question 2

A large law firm uses an average of 40 boxes of copier paper a day. The firm operates
260 days a year. Storage and handling costs for the paper are $30 a year per box, and it
costs approximately $60 to order and receive a shipment of paper.

a. What order size would minimize the sum of annual ordering and carrying costs?
b. Compute the total annual cost using your order size form part a.
c. Except for rounding, are annual ordering and carrying costs always equal at the
EOQ?
d. The office manager is currently using an order size of 200 boxes. The partners of
the firm expect the office to be managed “in a cost-efficient manner.” Would you
recommend that the office manager use the optimal order size instead of 200
boxes? Justify your answer.

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Question 3

A manager receives a forecast for the next year. Demand is projected to be 600 units for
the first half of the year and 900 units for the second half. The monthly holding cost is $2
per unit, and it costs an estimated $55 to process an order.

a. Assuming that monthly demand will be level during each of the six-month periods
covered by the forecast (e.g., 100 per month for each of the first six months),
determine an order size that will minimize the sum of ordering and carrying costs
for each of the six-month periods.
b. Why is it important to be able to assume that demand will be level during each
six-month period?
c. If the vendor is willing to offer a discount of $10 per order for ordering in
multiples of 50 units (e.g., 50, 100, 150), would you advise the manager to take
advantage of the offer in either period? If so, what order size would you
recommend?

Question 4

A company will begin stocking remote control devices. Expected monthly demand is 800
units. The controllers can be purchased from either supplier A or supplier B. Their price
lists are as follows:

Supplier A Supplier B
Quantity Unit Price Quantity Unit Price
1-199 $14.00 1-149 $14.10
200-499 $13.80 150-349 $13.90
500+ $13.60 350+ $13.70

Ordering cost is $40 and annual holding cost is 25 percent of unit price per unit. Which
supplier should be used and what order quantity is optimal if the intent is to minimize
total annual costs?

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Question 5

Burger Prince buys top-grade ground beef for $1.00 per pound. A large sign over the
entrance guarantees that the meat is fresh daily. Any leftover meat is sold to the local
high school cafeteria for 80 cents per pound. Four hamburgers can be prepared from each
pound of meat. Burgers sell for 60 cents each. Labor, overhead, meat, buns, and
condiments cost 50 cents per burger. Demand is normally distributed with a mean of 400
pounds per day and a standard deviation of 50 pounds per day. What daily order quantity
is optimal? (Hint: Shortage cost must be in dollars per pound.)

Question 6

A manager is going to purchase new processing equipment and must decide on the
number of spare parts to order with the new equipment. The spares cost $200 each, and
any unused spares will have an expected salvage value of $50 each. The probability of
usage can be described by this distribution:

Number 0 1 2 3
Probability 0.10 0.50 0.25 0.15

If a part fails and a spare is not available, it will take two days to obtain a replacement
and install it. The cost for idle equipment is $500 per day. What quantity of spares should
be ordered?

Question 7

Teddy Bower is an outdoor clothing and accessories chain that purchases a line of parkas
at $10 each from its Asian supplier, TeddySports. Unfortunately, at the time of order
placement, demand is still uncertain. Teddy Bower forecasts that its demand is normally
distributed with mean of 2,100 and standard deviation of 1,200. Teddy Bower sells these
parkas at $22 each. Unsold parkas have little salvage value; Teddy Bower simply gives
them away to a charity. How many parkas should Teddy Bower buy from TeddySports to
maximize expected profit?

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Question 8

Geoff gullo owns a small firm that manufactures “Gullo Sunglasses.” He has the
opportunity to sell a particular seasonal model to Land’s End. Geoff offers Land’s End
two purchasing options:

Option 1: Geoff offers to set his price at $65 and agrees to credit Land’s End $53 for
each unit Land’s End returns to Geoff at the end of the season (because those
units did not sell). Since styles change each year, there is essentially no value
in the returned merchandise.

Option 2: Geoff offers a price of $55 for each unit, but returns are no longer accepted.
In this case, Land’s End throws out unsold units at the end of the season.

This season’s demand for this model will be normally distributed with mean of 200 and
standard deviation of 125. Land’s End will sell those sunglasses for $100 each.

a. How much would Land’s End buy if they chose option 1?

b. How much would Land’s End buy if they chose option 2?
c. Which option will lead to higher expected sales?

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Answer Key
Please do NOT refer to the answers until you finish the questions on your own.

Q1:

D = 4,860 bags/year K = $10/order H = $75/bag/year

(a) Q* = (2DK) /H = (2486010) /75 = 36 bags

(b) Average number of bags on hand = 36/2 = 18 bags


(c) Number oforders per year = 4860/36 = 135 orders

(d) Total cost (AHO) = (18 * 75) + (135 * 10) = $2,700

(e) D = 4,860 bags/year K =$ 11/order H = $75/bag/year

New Q* = (2  486011) /75 = 37.75 bags, round off to 38 bags

Total cost (AHO) = (38/2 * 75) + (4860/38 * 11) = $2,831.80


If ordering costs were to increase by $1 per order, minimum total annual cost will
increase by 2,831.80 – 2,700 = $131.80.

Q2:
D = 40*260=10,400 boxes/year K = $60/order H = $30/box/year

(a) Q* = (2 10,400 60) /30 = 203.96  204

(b) Total annual cost (AHO) = (204/2 * 30) + (10,400/204 * 60) = $6,118.82

(Note: We can also use the AHOformula, i.e., AHO(Q*)  2DKH =$6,118.82.)

(c) Yes.

(d) Total annual cost (AHO) for 200 boxes = (200/2 * 30) + (10,400/200 * 60) = $6,120

Savings = 6,120 – 6,118.82 = $1.18

There is no compelling reason for the firm to use the optimal order size since it would
only save the firm $1.18, which is only $1.18/$6,120 =0.019%.

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Note: You can also use the sensitivity formula, and obtain the additional cost incurred
for ordering 200 boxes compared to the optimal one as follows:

AHO(200) 1 200 203.96

 (  )  1.00019 .
AHO(203.96) 2 203.96 200

Q3:

D = 600 (1st half); 900 (2nd half) K = 55 H = $12/unit/half a year

(a) 1st half of the year

Q* = (2 600 55) /12 = 74.16  75 (it’s rounded up to 75 because 75 is a

nice number to yield 8 orders in the 1st half of the year. Rounding off to 74 will
not change the AHO much due to the robustness of the EOQ model)
 AHO = (75/2 * 12) + (600/75

* 55) = $890

2nd half of the year

Q* = (2 900 55) /12 = 90.83  90 (90, instead of 91, is used because it leads
to exactly 10 orders in the second half of the year)
AHO = (90/2 * 12) + (900/90 * 55) = $1,090
 
(b) In order for the EOQ model to be applicable, it is important to assume that
demand will be level during each six-month period to satisfy the EOQ assumption
which states that demand occurs at a constant rate.

(c) 1st half of the year

D = 600 K = 45 H = 12

New Q* = (2 600  45) /12 = 67.08  67

We should order either 50 or 100.

If we
 order 50, 
AHO = (50/2 * 12) + (600/50 * 45) = $840
If we order 100,
AHO = (100/2 * 12) + (600/100 * 45) = $870
Based on the above calculations, the manager should take advantage of the offer
by ordering 50 units per order.
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2nd half of the year

D = 900 K = 45 H = 12

New Q* = (2 900  45) /12 = 82.16  82

We should order either 50 or 100.

If we
 order 50, 
AHO = (50/2 * 12) + (900/50 * 45) = $1,110
If we order 100,
AHO = (100/2 * 12) + (900/100 * 45) = $1,005
Based on the above calculations, the manager should take advantage of the offer
by ordering 100 units per order.

Q4:

D= 9600 K= 40

Supplier A
Quantity Unit Price Holding EOQ Q* Total Annual
Cost/Unit/yr Cost
1-199 $14.00 $3.50 468.4 199 $136,677.90
200-499 $13.80 $3.45 471.8 472 $134,107.76
500+ $13.60 $3.40 475.3 500 $132,178.00

Supplier B
Quantity Unit Price Holding EOQ Q* Total Annual
Cost/Unit/yr Cost

1-149 $14.10 $3.53 466.8 149 $138,199.79

149-349 $13.90 $3.48 470.1 349 $135,146.67
350+ $13.70 $3.43 473.5 474 $133,141.85

Based on the calculations above, the company should order 500 units a time from
Supplier A to minimize total annual cost.

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Q5:

Cost of underage (Cu) = $0.40/pound (The cost of underage would be the loss of profit
for each pound of meat shortage. Given that 1 pound of meat can be used for 4 burgers,
and the profit for each burger is $0.10, cost of underage equals 4 * 0.1 = $0.40 per pound.)
(Note: The cost for meat is included in $0.5/burger.)

Cost of overage (Co) = $1 - $0.80 = $0.20/pound

Cu 0.40
F(Q*) = = = 0.6667 (corresponding z-value = 0.43)
Cu  Co (0.20  0.40)

Q* = 400 + 0.43 (50) = 421.50 pounds

 

Q6:

C = 200 V = 50

Cost of underage (Cu) = 500 * 2 = 1,000

Cost of overage (Co) = 200 – 50 = 150

1000
F(Q*) = = 0.87
1000 150

Number 0 1 2 3
Probability 0.10 0.50 0.25 0.15
 Cumulative 0.10 0.60 0.85 1.00
Probability

3 spares should be ordered.

Q7:

R = 22 C = 10 V=0  = 2,1000  = 1,200

Cost of underage (Cu) = 22 – 10 = 12

Cost of overage (Co) = 10 – 0 = 10
 
12
F(Q*) = = 0.5455 (corresponding z-value = 0.12)
12 10
Q* = 2,100 + 0.12 (1,200) = 2,244


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Q8:

(a) Option 1

R = 100; C = 65;  = 200;  =125

Cost of underage (Cu) = 100 – 65 = 35

 = 65 – 53 = 12
Cost of overage (Co)

35
F(Q*) = = 0.7447 (corresponding z-value = 0.66)
35 12
Q* = 200 + 0.66 (125) = 282.5, round up to 283


(b) Option 2

R = 100; C = 55;  = 200;  =125

Cost of underage (Cu) = 100 – 55 = 45

Cost of   = 55 – 0 = 55
overage (Co)

45
F(Q*) = = 0.45 (corresponding z-value = -0.12)
45  55
Q* = 200 – 0.12 (125) = 185

(c)  both options, if actual demand realization x is below 185, then x units can be
For
sold.

However, if 185<x<283, then for option 1, x units can be sold (note that x>185);
while for option 2, only 185 units can be sold.

If x >= 283, then for option 1, 283 units can be sold; whereas for option 2, only
185 units can be sold.

Therefore, on average, option 1 leads to higher expected sales.

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