I.

Introduction
Functions of Inventories
Materials analysis is undoubtedly a vital task in any firm. It is essentially
responsible for planning, acquisition, storage, movement and control of materials
and final product.
Inventory analysis attempts to get the right goods at the right price at the right
time to maintain a desired service level at minimum cost.
Inventory analysis gives an answer to two problems related materials analysis function:
1) when should the inventory be replenished ?
2) how much should be ordered ?
Inventories may consist of supplier, raw materials, in process goods, subassemblies and
finished goods
Type of organization
A. Retail systems
1. sale of goods
2. sale of service
B. Wholesale/ distribution
systems
C. Manufacturing/ assembly
systems
1. continuous production
system
2. intermittent production
system

Supplies

Type of inventory
Raw
In-process
Material
goods

X
X
X

Finish
goods
X
X

Inventory Cost

C = Ch + Cs + Cp
C = total inventory cost/year
Ch = inventory holding cost / year
Cs = inventory shortage cost / year
Cp = inventory procurement cost per year
1

Lot Size Systems

Lot size system are deterministic systems with constant demand and with an (s,q)
policy in which s = 0, Shortages are not allowed and therefore holding cost are balanced
against replenishing costs. The problem consists in determining the optimal lot size q.
The Classical economics lot size system:
In this model following hypotheses are made:
Demand is at a constant rate of r units per units time (e.q. r =2,400 lb per year)
Replenishment are made whenever the inventory reaches the prescribe s = 0, level
so that no shortages can occur.
The replenishment size is constant, say q.
The replenishment rate is infinite. Infinite replenishing rates generally occur when
dealing with outside purchases.
Lead time is zero, However when lead time L is different of zero, there is no
difficulty to extend the model.
Unit holding cost is a constant per unit (ch)
Unit replenishing cost is a constant per order (cp)
The inventory fluctuations in t his system are illustrated by figure 1.
I (t) amount in inventory

q
q/2
0

t (time)

T
The average amount in inventory being I h

q
, one easily computes the
2

inventory holding cost.

Anual holding cost = (average inventory level) (Annual holding cost per
unit)
Ch (q)

ch q
2

If C0 is the cost of placing one order, the general equation fot

the annual ordering cost is as follows:

Annual Ordering Cost = (number of orders per year) (cost

per order)
The Ordering (procurement) cost is given by
C p (q )

c p .D
q

The total annual Cost, denoted TC, can be expresssed as follows:

As r/q represents the number of procurements per time unit (year)

By definition Cs (q) = 0, so
ch .q c p . .r

2
q

C (q )

To find the optimal lot size we derive C(q) with respect to q giving
C ( q) ch c p .r

2 0
q
2
q
q*

2c p .r
ch

C (q)

2ch .c p .r

Or
Q*

2c p .D
Ch

Example:
A customer orders from manufacturing company shipments of parts at
a uniform rate of 2400 part per year. The company makes the part the
on a machine that can produce any number of parts at a time. The cost
of machine set up is 4200 BF per production run. The holding is 56 BF
per part per year. No storages are allowed to occur. The manufacturing
companys inventory problem is ti find how many parts should be
produced for each production run.
Solution:
cp = 4200
r = 2400
ch = 56

q=

2(4200)( 2400)
600 parts / run
56

Total cost optimal or C(q)=

2(56)(4200)( 2400)

Lot Size
(q)

Average
Inventory
(q/2)

Holding
Cost Per
Year (r x 2)

Average number
of setups per
year (r/q)

100
200
300
400
500
600
700
800
900
1000
1100
1200

50
100
150
200
250
300
350
400
450
500
550
600

2800
5600
8400
11200
14000
16800
19600
22400
25200
28000
30800
33600

24.00
12.00
8.00
6.00
4.80
4.00
3.43
3.00
2.67
2.40
2.18
2.00

= 33.600 BF
Procurement
cost per
year (BF)
(cp.r)/q
100800
50400
33600
25200
20160
16800
14400
12600
11200
10080
9164
8400

Total cost
per year
(Ch+Cp)
103600
56000
42000
36400
34160
33600
34000
35000
36400
38080
39964
42000

Other Example
If the

Ch = $ 1,25
Cs = 20
Cp = $ 104,000
Solution ?

STATIC INVENTORY PROBLEM UNDER RISK

4

Problem
A student has obtained the concession for picnic lunches at local football game.
Records indicate the following demand distribution for lunches:

Demand X
0
1
2
3
4
5
6
Sum

Frequentions
0
10
10
30
30
10
10
100

P(x ) = Prob (x = X)
0.00
0.10
0.10
0.30
0.30
0.10
0.10
1.00

The lunches cost 30 BF and are sold 50 BF. Any lunches left over can be disposed for 5
BF. Determine the order quatity.
Cost Minimization
Let us now apply these principles to one example. Let (q,x) be the decision per
unitstate vector, where q represents the order quantity and x represents the quantity
demanded. Let C (q,x) be the cost associated to each pair (q, x). When then have
Kq W (q - x)

at x q

Kq + R (x q)

if x > q

C (q, x) =
Where
K = acquisition cost = 30 BF per unit
W= salvage value = 5 BF per unit
R = opportunity cost (revenue) = 50 BF per unit
The expected cost for a given order quantity q is then given by
E[C (q )

C (q, x ) p ( x )
x 0

E[C ( q) C ( q, x) p( x )
x 1

Because p (x) = 0 outside the range (1, 6)

The complete conditional cost matrix is shown in the table:
Conditional cost matrix
5

Order
quatity q
1
2
3
4
5
6
P (x)

1
30
55

)
0.1

2
80

Demand x
3
4
130
180

5
230

6
280

0.1

0.3

0.1

0.1

0.3

Expected
Cost E[C(q)]
155,0
139.5
128.5
131.0
147.0
167.5

Cost matrix (1,1) = Kq W(q-x) = 30 (1) 5 (1-1) = 30

Cost matrix (1,2) = Kq W(q-x) = 30 (2) 5 (2-1) = 55
Cost matrix (2,1) = Kq + R(x-q) = 30 (1) + 50 (2-1)= 80
Cost matrix (3,1) = Kq + R(x-q) = 30 (1) + 50 (3-1)= 130
Cost matrix (4,1) = Kq + R(x-q) = 30 (1) + 50 (4-1)= 180
Cost matrix (5,1) = Kq + R(x-q) = 30 (1) + 50 (5-1)= 230
Cost matrix (6,1) = Kq + R(x-q) = 30 (1) + 50 (6-1)= 280
6

E[C ( q) C ( q, x) p( x )
x 1

E [C (1) = 30 (0.1) + 80 (0.1) + 130 (0.3) + 180 (0.3) + 230 (0.1) + 280 (0.1) =
3 + 8 + 39 + 54 + 23 + 28 = 155,00

Profit Maximization
For problems involving major changes in revenue in which profit maximization is
objective, profits may be used as measure of performance rather then costs.
Let P (q,x) be the profit of each order quantity demand level pair. We have then

P (q,x)

P x L (q x)
Pq

if x q
if x > q

Where
P = profit per unit sold = 20 BF
L = loss per unit un sold = 25 BF
The expected profit for a given order quantity p
(decision variable) is:

E[ P ( q )]

P(q, x). p ( x)
x 0

P ( q, x ). p ( x)
x 1

Using the above data yields table

Order
Demand x
quatity q 1
2
3
4
5
1
20
20
20
20
20
2
-5
3
-30
4
-55
5
-80
6
-105
P (x)
0.1
0.1
0.3
0.3
0.1

6
20

Expected
Profit E[P(q)]
20
35.5
46.5
44.0
28.0
7.5

0.1