Case Study – Bell Computer Company

The Bell Computer Company is considering a plant expansion enabling the company to begin production
of a new computer product. You have obtained your MBA from the University of Phoenix and, as a vice-
president, you must determine whether to make the expansion a medium- or large- scale project. The
demand for the new product involves an uncertainty, which for planning purposes may be low demand,
medium demand, or high demand. The probability estimates for the demands are 0.20, 0.50, and 0.30,
respectively.

Case Study – Kyle Bits and Bytes

Kyle Bits and Bytes, a retailer of computing products sells a variety of computer-related products. One of
Kyle’s most popular products is an HP laser printer. The average weekly demand is 200 units. Lead time
(lead time is defined as the amount of time between when the order is placed and when it is delivered)
for a new order from the manufacturer to arrive is one week.

If the demand for printers were constant, the retailer would re-order when there were exactly 200
printers in inventory. However, Kyle learned demand is a random variable in his Operations
Management class. An analysis of previous weeks reveals the weekly demand standard deviation is 30.
Kyle knows if a customer wants to buy an HP laser printer but he has none available, he will lose that
sale, plus possibly additional sales. He wants the probability of running short (stock-out) in any week to
be no more than 6%.

Purpose of Assignment

This assignment has two cases. The first case is on expansion strategy. Managers constantly have
to make decisions under uncertainty. This assignment gives students an opportunity to use the
mean and standard deviation of probability distributions to make a decision on expansion strategy.
The second case is on determining at which point a manager should re-order a printer so he or she
doesn't run out-of-stock. The second case uses normal distribution. The first case demonstrates
application of statistics in finance and the second case demonstrates application of statistics in
operations management.

Assignment Steps

Resources: Microsoft Excel®, Bell Computer Company Forecasts data set, Case Study Scenarios

Write a 1,050-word report based on the Bell Computer Company Forecasts data set and Case
Study Scenarios.

Include answers to the following:

Case 1: Bell Computer Company

 Compute the expected value for the profit associated with the two expansion alternatives.
Which decision is preferred for the objective of maximizing the expected profit?
 Compute the variation for the profit associated with the two expansion alternatives. Which
decision is preferred for the objective of minimizing the risk or uncertainty?

Case 2: Kyle Bits and Bytes

 What should be the re-order point? How many HP laser printers should he have in stock

Case 1: Bell Computer Company

The Bell Computer Company has two expansion options: medium scale, and large scale.

For both medium scale expansion and large scale expansion, demand can be low, medium, or

high with probability of 0.2, 0.5, and 0.3 respectively. For medium scale expansion, profits in

case of low, medium and high demand are $50,000 , $150,000 and $200,000 respectively. For

large scale expansion, profits in case of low, medium, and high demand are $0, $100,000 and

$300,000 respectively. Management is facing dilemma whether to go for medium scale

expansion or large scale expansion. While large scale expansion has potential to generate higher

profit in case of high demand, the large scale expansion will generate lower profit than medium

scale expansion in case of low and medium demand. In case of low demand, the large scale

expansion results in nil profit. Clearly, large-scale expansion bears more risk than the low-scale

expansion.

The expected value is an anticipated value of an action. An action has multiple possible

outcomes. First, we need to determine probability of occurrence of each outcome. The expected
value is calculated by multiplying each possible outcomes by probability of occurrence of that

outcome, and adding all those values. (Hossein, 2014) Expected value of medium scale

expansion and large scale expansion will help the management choose the expansion option that

is most likely to generate higher profit.

The expected value of two alternatives are:

Medium scale expansion: $145

Large scale expansion: $140

The medium scale expansion alternative has higher expected value than large-scale

expansion project. Thus, medium-scale expansion is preferred for the objective of maximizing

expected profit.

Merely knowing expected value is not enough to take an informed decision. It is also

important to know how profits can deviate from the expected value. For this purpose, variance is

used. Variance measures how far a set of random values are spread from the mean value. Higher

variance means the random values are spread far from the mean. A low variance is desirable.

The variance of random variables is the expected value of squared deviation from the mean.

Mathematically, variance of discrete random variables is calculated as:

Var = E[(X-µ)2] = ∑[P(X)* (X-µ)2]

(Hossein, 2014)

The variance of medium-scale and large-scale expansion projects are:

Medium-scale expansion: 2,725

Large-scale expansion: 12,400

The variation for profit associated with large-scale expansion is much higher than the

variation for profit associated with medium-scale expansion.

Standard deviation is a measure of risk. Standard deviation is a measure used to quantify

the amount of variation of a set of data values. Standard deviation is calculated as square root of

variance. Low standard deviation indicates that random values tend to be close to the expected

value. A lower standard deviation indicates lower risk and a higher standard deviation indicates

higher risk.

The standard deviation of medium-scale and large-scale expansion projects are:

Medium-scale expansion: 52.202

Large-scale expansion: 111.355

 Lower value of standard deviation of medium-scale expansion indicates that medium-

scale expansion project is less risky than the large-scale expansion project. So, medium-scale

expansion project is preferred for the objective of minimizing the risk or uncertainty.

Recommendation

The medium-scale expansion project has higher expected value, and lower risk. Thus,

management should choose medium-scale expansion project.

Case 2: Kyle Bits and Bytes

Kyle Bits and Bytes is a retailer of computing products. Kyle’s most popular product is

an HP laser printer. For this product, average weekly demand is 200 units, and lead time is one

week. However, demand is not constant. Kyle has observed that weekly demand standard

deviation is 30. Kyle need to know when should they place order (i.e. reorder point), and

inventory level so that there is stock-out. If Kyle is not able to fulfill an order due to stock-out,

Kyle will lose that sale and possibly additional sale. Kyle has set maximum acceptable

probability of stock-out in any week to 6%. With this target, Kyle wants to know what should be

the re-order point and how many HP laser printers should be in stock.

Reorder point is the inventory level at which order should be placed. In this case, demand

is variable. For variable demand, it is assumed that demand can be described by a normal

distribution. The average demand for the lead tine is the sum of average daily demand for the
number of days in lead time period. This can be calculated by multiplying average daily demand

by the lead time. The variance of the distribution is calculated as the sum of daily variance for

the number of days in lead time.

Thus, reorder point R = dL + z*σ*√L

Where

d = Average daily demand

L = lead time

σ = Standard deviation of daily demand

z = Number of standard deviations corresponding to the service level probability

(Russell & Taylor, 2011)

Here,

d = 200/7 units

L = 7 days

σ = 30/7

Maximum accepted probability of stock out is 6%. It means, service level is 0.94

Using z-table, corresponding z- value is determined.

z = 1.56

Thus, reorder point R = (200/7)*7 + 1.56*(30/7)* √7 = 200 + 17.69 = 217.69

i.e. Kelly’s will place an order when inventory level reaches 218 units.

When demand is variable, there is chance of shortage (or stock out). Shortage can occur

during the need time. I firm needs to maintain safety stock to avoid the risk of stock out. The

safety stock is the additional inventory a firm maintains above expected demand to avoid stock

out. Firms use service level to determine safety stock. A firm decides what probability it can

afford of stock out. The service level is probability of no stock out during lead time. This

probability is called service level. (Russell & Taylor, 2011) For example, a service level of 90%

means there is 0.90 probability that firm will meet demand during lead time. It means, the

probability of stock out is 10%.

Safety stock is determined as:

Safety stock = z*σ*√L

L = lead time

σ = Standard deviation of daily demand

z = Number of standard deviations corresponding to the service level probability

In this case,

L = 7 days

σ = 30/7

Maximum accepted probability of stock out is 6%. It means, service level is 0.94
Using z-table, corresponding z- value is determined.

z = 1.56

Thus, Safety stock =1.56*(30/7)* √7 = 17.69 = 18 units

Thus, Kelly’s should maintain 18 units safety stock of HP laser printer to avoid stock out.

References

Hossein, P. (2014). Introduction to Probability, Statistics, and Random Processes. Kappa

Research.

Russell, R. S., Taylor, B. W. (2011). Operation Management. (7th ed.). Wiley Publication. John
Wiley & Sons.