Chapter 12Managing Inventories

TRUE/FALSE
1. An airline seat is an example of an asset held for future use or sale.
ANS: T

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2. Safety stock inventory is an additional amount of inventory kept over and above the average amount
required to meet demand during the lead time.
ANS: T

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3. Airline seats and call center phone lines are examples of inventory in service organizations.
ANS: T

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4. Maintaining large stocks of inventory is a requirement in today's supply chains in order to improve
profitability.
ANS: F

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5. Marketing an operations generally prefer high inventory levels while finance would prefer small
inventories.
ANS: T

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6. Work in process inventory is completed products ready for distribution or sale to customers.
ANS: F

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7. Safety stock inventory is an additional amount of inventory kept over and above the average amount
required to meet demand.
ANS: T

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8. Setup costs depend on the number of items manufactured.

ANS: F

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9. Inventory holding costs can be accurately measured by accounting departments.

ANS: F

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10. Costs associated with maintaining storage facilities such as gas and electricity, taxes, and insurance are
associated with fixed ordering costs.
ANS: F

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11. Larger orders result in higher total holding cost but lower total ordering cost.
ANS: T

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12. Overnight shipping for emergency orders and compensation for overbooking at a hotel are examples of
ordering costs.
ANS: F

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13. A stock-keeping unit is the same no matter at which location the item is found.
ANS: F

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14. RFID tags are often used to track stock keeping units in supply chains.
ANS: T

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15. Dependent demand, unlike independent demand, needs to be forecasted.

ANS: F

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16. An example of stochastic demand might be: "The daily demand for milk is normally distributed with a
mean of 150 gallons and a standard deviation of 15 gallons.
ANS: T

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17. Stochastic demand inventory models are easier to analyze and solve than deterministic models.
ANS: F

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18. Airline flights to ski areas near Denver, Colorado, probably have different means and variances
throughout the year. This is an example of dynamic demand.
ANS: T

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19. Lead time is the time it takes to prepare an order for shipping to a customer.
ANS: F

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20. When a customer is unwilling to wait for an item that is not in stock and purchases the item elsewhere,
a backorder has occurred.
ANS: F

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21. "C" items are the critical few that must be closely managed in an inventory system.
ANS: F

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22. "A" items typically comprise a high percentage of total dollar usage but a low percentage of unit
volume.
ANS: T

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23. Inventory position refers to the physical quantity of items on hand in an inventory system.
ANS: F

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24. Because the fixed quantity system orders the same amount each time, time between orders will be
constant, even with variable demand.
ANS: F

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25. In a fixed quantity inventory system with certain demand, the reorder point is chosen to be the average
demand during the lead time.
ANS: T

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26. The Economic Order Quantity model (EOQ) allows for variable lead-time.
ANS: F

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27. In general, total ordering costs are equal to total inventory holding cost for the optimal solution to the
EOQ model.
ANS: T

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28. Because of demanding customers, organizations must always maintain a 100% service level.
ANS: F

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29. In the fixed period system, managers must make two key decisions: the time interval between reviews,
and the replenishment level.
ANS: T

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30. In a single-period inventory situation, the only inventory decision is when to trigger an order.
ANS: F

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31. The decision of how many fruit baskets to make for the holiday season would be analyzed using a
single-period inventory model.
ANS: T

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32. Many practical inventory situations include backorders and quantity discounts.
ANS: T

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MULTIPLE CHOICE
1. In ABC inventory analysis, which of the following is true for C items?
a. Tighter control of C items (than for A or B items) is appropriate.
b. C items are critical items that must be monitored with a fixed period system.
c. C items make up a lower percentage of total inventory value ($) than either A or B
items.
d. C items make up 10-20 percent of inventory items.
ANS: C

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2. Inventory that represents partially completed products waiting further processing is called ____
inventory.
a. Raw materials
b. Work-in-process
c. Cycle
d. Safety stock
ANS: B

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3. Additional inventory kept over and above the average amount required to meet demand is called
____ inventory.
a. Seasonal
b. Work-in-process
c. Finished goods
d. Safety stock
ANS: D

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4. Inventory that acts as a buffer between workstations in flow shops or departments in job shops is
called ____ inventory.
a. Raw materials
b. Work-in-process
c. Cycle stock
d. Safety stock
ANS: B

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5. Costs associated with inspecting, unpacking and putting into storage incoming inventory are
components of ____ cost.
a. Ordering or setup
b. Holding
c. Shortage
d. Unit
ANS: A

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6. Which of the following is not a component of holding cost?

a. Taxes
b. Insurance
c. Material handling
d. Order processing
ANS: D

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7. Costs associated with backordering a product are called ____ costs.

a. Holding
b. Shortage
c. Ordering
d. Setup
ANS: B

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8. Which one of the following statements is true?

a. The EOQ is most accurate when both inventory and order costs are estimated on a full cost
basis.
b. The EOQ is most accurate when both inventory and order costs are estimated on a pure

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variable cost basis.

c. The EOQ is most accurate when inventory costs are estimated on a full cost basis while
order costs are estimated on a pure variable cost basis.
d. The EOQ is most accurate when inventory costs are estimated on a pure variable cost basis
while order costs are estimated on a full cost basis.
ANS: B

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9. Which one of the following statements is true?

a. Inventory is any physical asset held for future use or sale.
b. When using ABC analysis, C items should be reviewed most frequently.
c. Dependent demand is directly related to the demand of other stock keeping units and can
be calculated without needing to be forecast.
d. Stockouts occur in a Fixed Quantity System (FQS) whenever the lead-time demand
exceeds the replenishment level (M).
ANS: C

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10. Which one of the following is not true regarding the Fixed Period System (FPS)?
a. The time between orders is constant, but the order quantity might vary.
b. An order is time-triggered, not inventory-triggered.
c. The optimal replenishment level includes the demand during the review period plus any
desired safety stock.
d. When demand is not certain, the FPS requires more safety stock than the equivalent FQS.
ANS: C

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11. Two fundamental inventory decisions are when to order and how much to order. Which of the
following statement is true with respect to Fixed Quantity (FQS) and Fixed Period (FPS) inventory
systems?
a. A FPS orders a fixed period quantity when the inventory position reaches or drops below
the reorder point (r).
b. A FPS must cover a time period of T + L to cover the risk of a stock out.
c. A FPS places an order for the economic order quantity every T time units.
d. A FQS places an order to replenish the inventory position up to a target level (M) when the
inventory position reaches the reorder point (r).
ANS: B

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12. Independent demand

a. can be derived/calculated
b. is related to other SKUs
c. is also called finished goods inventory
d. needs to be forecasted
ANS: D

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13. Demand that incorporates uncertainty is called ____.

a. Static
b. Dynamic
c. Stochastic
d. Deterministic
ANS: C

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14. Demand that varies over time is called ____.

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a.
b.
c.
d.

Static
Dynamic
Stochastic
Deterministic

ANS: B

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15. Demand that is stable over time is called ____.

a. Static
b. Dynamic
c. Stochastic
d. Deterministic
ANS: A

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16. Which of the following is incorrect regarding inventory management?

a. The two fundamental inventory decisions are when to order and what to order
b. Inventory management applies to goods and to services
c. Different types of inventory characteristics require different approaches for control
d. SKUs are often aggregated or partitioned into groups with similar characteristics or dollar
value
ANS: A

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17. Backorders ____.

a. Result from lost sales
b. Have little financial impact
c. May occur as a result of a stockout
d. Force a customer to purchase elsewhere
ANS: C

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18. Using ABC analysis, continuous monitoring and accurate record keeping relates best to ____ items.
a. A
b. B
c. C
d. B and C
ANS: A

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19. The inability to satisfy the demand for an item is the definition of a
a. reorder point
b. stockout
c. lost sale
d. backorder
ANS: B

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20. Inventory position is computed using all the following except

a. On-hand
b. Scheduled receipts
c. Backorders
d. Lead time demand
ANS: D

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21. Using a fixed quantity system (FQS), as the reorder point increases
a. safety stock increases
b. safety stock decreases
c. the number of orders increases
d. the number of orders decreases
ANS: A

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22. Which of the following is not a key assumption underlining the classic economic order quantity (EOQ)
model?
a. The entire order quantity arrives in the inventory at one time
b. There are only two types of relevant costs: order/setup and inventory-holding
c. Demand is assumed to be stochastic
d. Stockouts are not allowed
ANS: C

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23. Which is not an advantage of the periodic review system?

a. Helps to control "A" items
b. Inventory need not be monitored continually
c. Useful when a large number of items is ordered from the same supplier
d. Consolidated shipments lower freight costs
ANS: A

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24. Average inventory in the EOQ model is defined as

a. The order quantity divided by the number of inventory cycles per year
b. Annual usage divided by the number of inventory cycles per year
c. One-half the order quantity
d. One-half the annual usage
ANS: C

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25. Which of the following is not a key input to a single period inventory model?
a. Probability distribution of demand
b. Probability that demand is less than the optimal order quantity
c. Cost per item of overestimating demand
d. Cost per item of underestimating demand
ANS: B

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26. Which one of the following statements is true?

a. The level of safety stock maintained decreases when the desired cycle-service level
increases.
b. The level of safety stock maintained decreases when the standard deviation of demand
during lead time increases.
c. In a fixed period inventory system, the value of Q is kept the same from one cycle to
another.
d. When demand is uncertain and no safety stock is maintained, stock outs will occur during
approximately 50 percent of the cycles.
ANS: D

PTS: 1

27. Which one of the following statements concerning the economic order quantity (EOQ) model is not
true when the unit holding cost increases?
a. the economic order quantity will decrease

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b. the number of orders per year will decrease

c. total ordering cost will increase
d. average inventory will decrease
ANS: C

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28. For the single-period inventory model, solving for the optimal order quantity involves using
a. marginal economic analysis
b. total cost analysis
c. ABC analysis
d. reorder point analysis
ANS: A

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SHORT ANSWER
1. What is inventory management and why is it important?
ANS:
Inventory management involves planning, coordinating, and controlling the acquisition, storage,
handling, movement, distribution, and possible sale of raw materials, component parts and
subassemblies, supplies and tools, replacement parts, and other assets that are needed to meet customer
wants and needs. The expenses associated with financing and maintaining inventories are a substantial
part of the cost of doing business (i.e., cost of goods sold). Managers are faced with the dual
challenges of maintaining sufficient inventories to meet demand while at the same time incurring the
lowest possible cost.
PTS: 1
2. Explain the different types of inventories maintained throughout a value chain.
ANS:
Raw materials, component parts, subassemblies, and supplies are inputs to manufacturing and
service-delivery processes. Work-in-process (WIP) inventory consists of partially finished products
in various stages of completion that are waiting further processing. WIP inventory also acts as a buffer
between workstations in flow shops or departments in job shops to enable the operating process to
continue when equipment might fail at one stage or supplier shipments are late. Finished goods
inventory are completed products ready for distribution or sale to customers. To reduce the risk
associated with not having enough inventory, firms often maintain additional stock beyond their
normal estimates. Safety stock inventory is an additional amount that is kept over and above the
average amount required to meet demand.
PTS: 1
3. What are the four categories of inventory costs?
ANS:
1.
Ordering costs or setup costs are incurred as a result of the work involved in placing
orders with suppliers or configuring tools, equipment, and machines within a factory to
produce an item. Order and setup costs do not depend on the number of items purchased
or manufactured, but rather on the number of orders that are placed.
2.
Inventory-holding or inventory-carrying costs are the expenses associated with
carrying inventory. Holding costs are typically defined as a percentage of the dollar
value of inventory per unit of time (generally one year). They include costs associated

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3.

4.

with maintaining storage facilities, such as gas and electricity, taxes, insurance, and labor
and equipment necessary to handle, move, and retrieve an SKU.
Shortage or stockout costs are costs associated with a SKU being unavailable when
needed to meet demand. These costs can reflect backorders, lost sales, or service
interruptions for external customers, or costs associated with interruptions to
manufacturing and assembly lines for internal customers.
Unit cost is the price paid for purchased goods or the internal cost of producing them. In
most situations, the units cost is a "sunk cost" because the total purchase cost is not
affected by the order quantity.

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4. Summarize the characteristics of the inventory environment that management considers when
developing an inventory management system.
ANS:
The characteristics management considers when developing an inventory management system includes
the following:
Number of items (SKUs) - one or many

Nature of demand - independent or dependent, deterministic or stochastic, static or

dynamic
Number and duration of time periods single-period or multiple-period

Lead time - deterministic or stochastic

Stockouts - backorders or lost sales

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5. Explain the difference between independent demand and dependent demand.
ANS:
Independent demand is demand for a SKU that is unrelated to the demand for other SKUs and needs
to be forecast. This type of demand is directly related to customer (market) demand. Inventories of
finished goods have independent demand characteristics.
Dependent demand is directly related to the demand of other SKUs and can be calculated without
needing to be forecast. For example, the demand for chandeliers is independent, while the demand for
the bulb sockets used in the chandeliers is dependent on the demand for chandeliers.
PTS: 1
6. Discuss two types of stockouts.
ANS:
When stockouts occur, the item is either back-ordered or a sale lost. A backorder occurs when a
customer is willing to wait for the item. Backorders result in additional costs for transportation,
expediting, or perhaps buying from another supplier at a higher price. A lost sale occurs when the
customer is unwilling to wait and purchases the item elsewhere. A lost sale has an associated
opportunity cost which might include loss of goodwill and potential future revenue.
PTS: 1
7. Explain the ABC inventory classification.
ANS:

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ABC analysis consists of categorizing inventory items or SKUs into three groups according to their
total annual dollar usage. It is based on the Pareto principle.
"A" items account for a large dollar value but a relatively small percentage of total items.

Typically, A items comprise 60 to 80 percent of the total dollar usage, but only 10 to 30
percent of the items.
"C" items account for a small dollar value but a large percentage of total items. Typically,

C items account for 5 to 15 percent of the total dollar usage and about 50 percent of the
items.
"B" items are between A and C.

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8. Define the EOQ model and explain its major assumptions.
ANS:
The Economic Order Quantity (EOQ) Model is a classic economic model that minimizes total cost,
which is the sum of the inventory-holding cost and the ordering cost. Several key assumptions underlie
the development of a quantitative model...
Only a single item (SKU) is considered.

The entire order quantity (Q) arrives in the inventory at one time. No physical limits are

placed on the size of the order quantity, such as shipment capacity or storage availability.
Only two types of costs are relevant - order/setup and inventory-holding costs.

No stockouts are allowed.

The demand for the item is deterministic and continuous over time. This means that units

are withdrawn from inventory at a constant rate proportional to time. For example, an
annual demand of 365 units implies a weekly demand of 365/52 and a daily demand of
one unit.
Lead time is constant.

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9. Explain the difference between a fixed quantity system and a fixed period system.
ANS:
In a fixed quantity system (FQS), the order quantity or lot size is fixed; that is, the same amount, Q,
is ordered every time. A way to manage a FQS is to continuously monitor the inventory level and place
orders when the level reaches some "critical" value. A fixed period system (FPS) sometimes called a
periodic review system is one in which the inventory position is checked only at fixed intervals of
time, T, rather than on a continuous basis. At the time of review, an order is placed for sufficient stock
to bring the inventory position up to a predetermined maximum inventory level, M, sometimes called
the replenishment level, or "order-up-to" level.
PTS: 1
10. Discuss the concept of safety stock in a fixed order quantity system with uncertain demand.
ANS:
Stockouts occur whenever the lead-time demand exceeds the reorder point. When demand is
uncertain, using EOQ based solely on the average demand will result in a high probability of a
stockout. One way to reduce this risk is to increase the reorder point by adding additional stock
called safety stock to the average lead-time demand. Safety stock is additional planned on-hand
inventory that acts as a buffer to reduce the risk of a stockout.
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11. Provide some examples of when the single period inventory model is applicable.
ANS:
The single-period inventory model applies to inventory situations in which one order is placed for a
good in anticipation of a future selling season where demand is uncertain. At the end of the period the
product has either sold out, or there is a surplus of unsold items to sell for a salvage value. Singleperiod models are used in situations involving seasonal or perishable items that cannot be carried in
inventory and sold in future periods. Examples include any seasonal, perishable or one-time purchase
such as holiday candy, Christmas trees, newspapers and magazines, and contracts on number of weeks
to show a new movie.
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PROBLEM
1. Given the information below, conduct an ABC analysis and determine which items should be classified
as A, B and C.
SKU
A
B
C
D
E
F
G

Annual Usage
2,800
300
275
700
45
1,250
2,000

Item Value ($)

0.22
50.00
11.00
8.00
400.00
0.80
0.60

ANS:
SKU
E
B
D
C
G
F
A

Annual
Usage
45
300
700
275
2,000
1,250
2,800

Item
Value ($)
400.00
50.00
8.00
11.00
0.60
0.80
0.22

Annual
Dollar Usage
18,000.00
15,000.00
5,600.00
3,025.00
1,200.00
1,000.00
616.00

Cumulative $
$ 18,000.00
$ 33,000.00
$ 38,600.00
$ 41,625.00
$ 42,825.00
$ 43,825.00
$ 44,441.00

Percent of
Total $
40.5%
74.3%
86.9%
93.7%
96.4%
98.6%
100.0%

Based on this information, we would probably consider E and B as "A" items; D and C as "B" items;
and G, F and A as "C" items.
PTS: 1
2. Given the information below, conduct an ABC analysis and suggest which items should be classified
as A, B and C.
SKU
1
2
3
4
5
6

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Annual Usage
9,000
12,000
24,000
42,000
55,000
140,000

Item Value ($)

80.00
58.80
76.20
48.00
30.00
2.20

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7
8

33,000
3,000

48.00
110.00

ANS:
SKU
4
3
5
7
1
2
8
6

Annual
Usage
42,000
24,000
55,000
33,000
9,000
12,000
3,000
140,000

Item
Value ($)
48
76.2
30
48
80
58.8
110
2.2

Annual Dollar
Usage
$ 2,016,000.00
$ 1,828,800.00
$ 1,650,000.00
$ 1,584,000.00
$ 720,000.00
$ 705,600.00
$ 330,000.00
$ 308,000.00

Cumulative $
$ 2,016,000.00
$ 3,844,800.00
$ 5,494,800.00
$ 7,078,800.00
$ 7,798,800.00
$ 8,504,400.00
$ 8,834,400.00
$ 9,142,400.00

Percent of
Total $
22.1%
42.1%
60.1%
77.4%
85.3%
93.0%
96.6%
100.0%

From this table, an A-item classification might be SKU #4, 3, 5 and 7, although this might be subject
to some debate. C items appear to be SKU #8 and 6, while the remaining would probably be classified
as B items.
PTS: 1
3. Using the data below, find the EOQ, the total annual cost associated with the economic order quantity,
and the reorder point.
Annual Demand:
Weeks Operating:
Ordering Cost:
Holding Cost:
Lead-Time:

8,000 units
52/year
$35/order
$4/unit/year
3 weeks

ANS:

Q* = Sq. root of (2 x 8000 x 35/4) = 374

TC = 0.5(374)(4) + (8000/374)(35) = 748 + 748 = $1496 (to within rounding)

To find the reorder point, note that the weekly demand is 8000/52 = 153.85. During the 3-week lead
time we anticipate 3(153.85) = 462 (rounded) units to be sold.
PTS: 1
4. Using the data below, find the EOQ, the total annual cost associated with the economic order quantity,
and the reorder point.
Annual Demand:
Weeks Operating:
Ordering Costs:
Holding Costs:
Lead-Time:
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15,000 units
52 weeks/year
$60/order
$7/unit/year
5 weeks
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ANS:

Q* = Sq. root of (2 x 15000 x 60/7) = 507

TC = 0.5(507)(7) + (15000/507)(60) = 1775 + 1775 = $3550 (to within rounding)

To find the reorder point, note that the weekly demand is 15000/52 = 288.5. During the 5-week lead
time we anticipate 5(288.5) = 1442 (rounded) units to be sold.
PTS: 1
5. A hotel purchases 8,000 gallons of a cleaning product. Each gallon costs $10 and the cost of holding
one gallon for a year is estimated to be $3. Ordering cost amounts to $30 per order.
a.
b.
c.

If the hotel orders in lots of 500 gallons, how many orders does it place each year?
What are the ordering and holding costs, and total annual cost?
If the economic ordering quantity is used, how much improvement in cost will result?

ANS:
a. Number of orders/year = D/Q = 8000/500 = 16
b.
TC = .5(500)(3) + (8000/500)(30) = $750 + $480 = $1230
The holding cost is $750 and the ordering cost is $480.
c.
= Sq. root of (2 x 8000 x 30/3) = 400
TC = .5(400)(3) + (8000/400)(30) = $600 + $600 = $1200
Although ordering cost increases, holding cost decreases, saving a total of $30 annually.
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6. A bookstore must decide on how many calendars to order for the next year. Each calendar costs $2 and
is sold for $4.50. After January 1, any unsold calendars are returned to the publisher for a refund of
$0.75 each. The distribution of demand is uniform between 100 and 300. How many calendars should
the bookstore order?
ANS:
cu = 4.50 2 = 2.50
cs = 2 0.75 = 1.25
P(demand < Q*) = 2.50/(2.50 + 1.25) = 0.667
Q* = 100 + .667(300 100) = 233 calendars

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PTS: 1
7. A 4th of July celebration T-shirt for this year will cost festival organizers $12 each and will sell for $25
before and on July 4th. Any unsold T-shirts can usually be disposed of at a discount after the festival
for $5 each. If demand is normally distributed with a mean of 1,800 T-shirts and a standard deviation
of 75, how many T-shirts should be ordered?
ANS:
cu = 25 12 = 13
cs = 12 5 = 7
P(demand < Q*) = 13/(13 + 7) = 0.65
z = (Q* 1800)/75 = 0.39
Q* = 1,829
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8. A merchant wants to stock Christmas trees. She can place only one order per season. The merchant
pays $30 for each tree and sells them for $80 each. She will incur an additional cost of $6 each for
unsold trees that must be hauled to the landfill. If demand for Christmas trees is normally distributed
with a mean of 365 trees and a standard deviation of 46 trees, how many trees should she order?
ANS:
cu = 80 30 = 50
cs = 30 + 6 = 36
P(demand < Q*) = 50/(50 + 36) = 0.58
z = (Q* 365)/46 = 0.0319
Q* = 366
PTS: 1
9. The owner of a garden supply store was wondering if they could manage their inventory better. She
decided to develop an ABC classification system to help manage the inventory. The company's
inventory consists of the following items:

Garden Tool
Shovel
Edger
Weeder
Hose
Cutters
Sprinkler
Hedge Trimmer
Spreader
Sprayer
Clippers

Cost
$ 5.00
$25.00
$ 6.00
$20.00
$ 4.00
$ 7.00
$ 5.00
$15.00
$12.00
$ 8.00

Quarterly Demand
(units)
1,000
6
400
800
100
800
5,000
6
20
15

a. Compute the total dollar value of each of the ten inventory items. What is the total value of all the
inventory items?
b. Which items should be declared "A" items? What percentage of total inventory value does your
A group represent? What percentage of the total number of inventory items does your A
group represent?

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c. Which items should be declared "B" items? What percentage of total inventory value does your
B group represent? What percentage of the total number of inventory items does your B
group represent?
d. Which items should be declared "C" items? What percentage of total inventory value does your
C group represent? What percentage of the total number of inventory items does your C
group represent?
ANS:
a.

Tool
Shovel
Weeder
Hose
Sprinkler
Hedge trimmer
Sprayer
Clippers
Cutters
Edger
Spreader
Total

Value
$ 5,000
$ 2,400
$16,000
$ 5,600
$25,000
$ 240
$ 120
$ 400
$ 150
$
90
$55,000

b.

A Items
Hedge trimmer
Hose
Total

Value
$25,000
$16,000
$41,000

% Inventory
Value

% Total
Items

74.5%

20%

% Inventory
Value

% Total
Items

23.6%

30%

% Inventory
Value

% Total
Items

1.8%

50%

c.

B Items
Sprinkler
Shovel
Weeder
Total

Value
$ 5,600
$ 5,000
$ 2,400
$13,000

d.

C Items
Cutters
Sprayer
Edger
Clippers
Spreader
Total

Value
$ 400
$ 240
$ 150
$ 120
$
90
$1,000

PTS: 1

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10. A local furniture store is examining its inventory policy and considering using an economic
order quantity (EOQ) approach for a popular table set that they have had difficulty keeping in
stock. They have the following information about the table set:
Annual demand = 3,920 sets
Current order quantity = 80 sets
Carrying cost = $80.00/set/year
Order cost = $200
a. What is the current total annual cost (TC)?
b. What is the EOQ?
c. What is the total annual cost at the EOQ?
ANS:
a. TC

= (Q/2) Co + (D/Q) Ch
= (80/2) 80 + (3,920/80) (200)

= 3,200 + 9,800 = $13,000

b. EOQ

= Sq. Root of 2DCo/Ch

= Sq. Root of [(2)(3,920)(200)]/2 = 140 sets

c. TC

= (140/2)(80) + (3,920/140)(200)
= 5,600 + 5,600 = $11,200

PTS: 1
11. The operations manager at a chemical company that produces insecticide for use in commercial
applications is attempting to set a safety stock level for a key ingredient that is used in their most
powerful product. She believes that demand during lead time for this ingredient is normally distributed
based on past data. In addition, she believes that future use is accurately depicted by these historical
demand-during-lead-time data (in gallons): 55, 75, 75, 70, 80, 60, 50, 70, 60, and 85. She estimates
the standard deviation of demand during the lead time to be 8.5 gallons.
a. What is the average demand during the lead time for this key ingredient?
b. What is the safety stock they need to provide a 95% service level?
c. What is the order point the company should use?
ANS:
a. L = (55 + 75 + 75 + 70 + 80 + 60 + 50 + 70 + 60 + 85)/10 = 680/10 = 68 gallons
b. zL = (1.645)(8.5) = 13.9825 = 14 gallons
c. r = L + zL = 68 + 14 = 82 gallons
PTS: 1
12. The recently hired floor manager at the local store of a national home improvement chain is studying
their inventory system. He has chosen patio blocks to be the first item examined. The historical supply
and demand data for this item has indicated a constant lead time of 16 days. Demand per day (d) is
normally distributed with a mean demand of 2000 per day and standard deviation of 240 per day. He
plans to set the service level at 90% during lead time.

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a. What is the average demand during lead time?

b. What is the amount of safety stock of blocks he should keep on hand?
c. What is the order point he should use?
ANS:
a L = tT = 2000(16) = 32,000 blocks
b. zL = 1.283(t)(sq. root of L) = 1.283(240)(sq. root of 16) = 1,231.68 = 1,232 blocks
c. r = L + zL = 32,000 + 1,232 = 33,232 blocks
PTS: 1
13. An auto parts store (open 350 days per year) in a major metropolitan area reviews its inventory on a
periodic basis using a computer system. It has recently been experiencing some problems with a
particular part, a tune-up kit. The kit is bought from a U.S. manufacturer. The annual demand for these
kits is 10,500. The cost to carry one kit in inventory for one year is $4.90, and the cost to place a
replenishment order is $17 per order. Replenishment lead time is 4 days.
a. What should be the review period for these tune-up kits?
b. What is the optimal replenishment level without safety stock?
c. What is the optimal replenishment level with safety stock, assuming a 95 percent service level?
ANS:
a. EOQ = Q* = Sq. root of [2(10,500)(17)/4.90] = 269.92 = 270 kits
T = Q*/D = 270/10,500 = .025714 years = .025714(350) = 9 days
b. d = 10,500/350 = 30 kits per day
M = d(T + L) = 30(9 + 4) = 390 kits
c. T+L = d(sq. root of T + L) = 30(sq. root of 9 + 4) = 108.17 kits
zT+L = 1.645(108.17) = 177.94 = 178 kits
M = 390 + 178 = 568 kits
PTS: 1
14. Peterson Enterprises uses a fixed order quantity inventory control system. The firm operates 50
weeks per year and has the following characteristics for an item:
Demand = 50,000 units/year
Ordering cost = $35/order
Holding cost = $2/unit/year
Lead time = 3 weeks
Standard deviation in weekly demand = 125 units
a. What is the EOQ for this item?
b. If Peterson wishes to provide a 90 percent cycle-service level, what is the reorder point with safety
stock?
ANS:
a. Q* = Sq. root of [2(50,000)(35)/2] = 1,322.88 units

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b. L = t(sq. root of L) = 125(sq. root of 3) = 216.51 units

r = L + zL = 3(50,000/50) + 1.283(216.51) = 3,000 + 277.78 = 3,278 units
PTS: 1
15. Alice opens an aquarium store in a lively shopping mall and finds business to be booming but she
often stocks out of key items customers want. She decides to experiment with inventory control
methods such as using a fixed order quantity (FQS) and/or fixed order period (FPS) systems. The
FLUVAL 303 Pump, a high margin and profitable pump, is one of her best sellers but it stocks out
frequently. You collect the following date with respect to this pump's sales.
Demand = 5 units per week
Order cost = $40/order
Item cost = $80/pump
Inventory holding cost = 15% per year

Store open 50 weeks/year

Lead-time = 3 weeks

a. What is the Economic Order Quantity (EOQ) rounded to the next highest number?
b. If the current order quantity used by Alice is 20 pumps per order, how much money can she save
annually by adopting an EOQ ordering policy?
c. If Alice decides to use a FPS, what is the economic fixed order interval?
ANS:
a. Q* = Sq. root of [2(250)(40)/12] = 40.825 = 41 pumps
b. TC = Co(D/Q) + Ch(Q/2) = 40(250/20) + 12(20/2) = 500.00 + 120.00 = $620.00
TC* = Co(D/Q*) + Ch(Q*/2) = 40(250/41) + 12(41/2) = 243.90 + 246.00 = $489.90
Annual saving = 620.00 489.90 = $130.10
c. T = Q*/d = 41/250 = .164 years = .164(50 weeks) = 8.2 weeks
PTS: 1
16. You manage a candy store in a high traffic shopping mall where you have collected the following
information. Answer the next four questions based on these data.
Weekly demand for small candy boxes = 90 boxes
Cost to place one purchase order with the box supplier = $19.80
Cost to hold one box for one year in inventory = $2.45
Lead time = 2 weeks
Weeks in a year = 52 weeks
a.
b.
c.
d.

What is the Economic Order Quantity (EOQ)?

Assuming the EOQ is ordered, what is the average inventory level (i.e., cycle inventory)?
Assuming the EOQ is ordered, what is the total annual order and inventory holding cost?
If a Fixed Period System (FPS) is adopted, what is the replenishment level (M) without safety
stock?

ANS:
a. Q* = Sq. root of [2(4,680)(19.80)/2.45] = 275.035 = 275 boxes
b. Q*/2 = 275/2 = 137.50 boxes
c. TC = Co(D/Q*) + Ch(Q*/2) = 19.80(4680/275) + 2.45(275/2) = 336.96 + 336.88 = $673.84

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d. T = Q*/d = 275/90 = 3.056 = 3 weeks

M = d(T + L) = 90(3 + 2) = 450 boxes
PTS: 1
17. Cynthia Baker, manager of a large medical supply house that operates 50 weeks per year and 5 days
per week, has decided to implement a fixed period inventory system for all class A items. One such
item has the following characteristics:
Demand = 10,000 units/year
Order cost = $50/order
Holding cost = $5/unit/year
If Baker wishes to minimize total cost (thereby approximating the EOQ), what should be T, the
number of workdays between orders (i.e., review period)?
ANS:
Q* = Sq. root of [2(10,000)(50)/5.00] = 447.214
T = Q*/D = 447.214/10,000 = .0447214 years = .0447214(250) = 11.18 = 11 days
PTS: 1
18. Bishop Manufacturing is implementing an economic order quality (EOQ) inventory control system
and needs a good estimate of the cost to process a purchase order (PO). It takes 5 total labor hours to
process a PO. The average number of SKUs on a PO is 2.2. The average wage for people working in
the purchasing department is $22 per hour plus employee benefits of $3 per hour. Fixed costs for the
purchasing department are $250,000 per year assuming a 2,000 hour per employee per year work
week. Given this information a good estimate of the cost to process one purchase order is
ANS:
Co = [($22 + $3)(5 hrs.)]/2.2 = $56.82
PTS: 1

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