Chapter 8
Material Quantitative Models for Planning and Control
Discussion Questions
1) The three key questions to answer in designing an
inventory control system are: (a) how much to
ordereconomic order quantity (b) when to order
order point (c) safety stock required
2) The firm benefits from these techniques by having
a consistent, standardized approach to its inventory
management. Inventory costs and service to
customers will be optimally balanced.
3) The purpose of an economic order quantity model
is to determine the optimum quantity to order or
produce when filling inventory needs. The optimum
quantity is defined as that quantity that minimizes the
cost of inventory management.
4) (a) The level of inventory at which new order
should be placed for material (b) time required to get
delivery at factory store (c) reserve stock kept for use
in case of delivery is late, so production may carry
on.
5) The decision concerning how much to order or
produce at a given time involves a compromise
between inventory carrying costs and ordering or
setup costs. Examples of inventory carrying costs are:
interest on the money invested in inventories that
could have been invested elsewhere, property tax and
insurance, warehousing or storage, handling,
deterioration, and obsolescence. Ordering costs
include the cost of preparing the requisition and
purchase order, receiving the order, and accounting
for the order. Setup costs involve the costs of setting
up equipment to make the actual production runs. For
all these costs, only those that vary with activity are
relevant to the EOQ model.
6) (a) late delivery (b) transportation cost (c)
competitive price from supplier (d) safety stock (e)
order point
7) If inventory is used more than normal use due to
heavy order, EOQ model may prove inefficient.
Because heavy order requires more material on time
to complete the order and delivery it to customer on
time.
8) The consequences of maintaining inadequate
inventory levels include higher purchasing, handling,
and transportation costs, loss of quantity discounts,
production disruptions; inflation-related price
increases when purchases are deferred, and lost sales
and customer goodwill.
Measurement of the costs of lost orders and lost
repeat business is not easy because measurement may
be largely subjective. On the other hand, the other
factors listed can be measured with fair certainty and
greater ease.
9) Materials requirements planning (MRP) is a
computer simulation that integrates each products
bill of materials, inventory status, and manufacturing
process into a feasible production plan.
10) Effective utilization of capital, which includes
investment in inventory, is the responsibility of
general management; therefore, the primary interest
is in financial control. Although general or top-level
management is interested in providing customers
with good products and services, the scheduling of
production involves unit control primarily and is the
responsibility of production and purchasing
departments.
11) In the control of materials, the opposing needs
are the maintenance of an inventory of sufficient size
and diversity for efficient operations, and the
maintenance of an investment in inventory at a level
that will maximize earnings and minimize costs.
12) (a) reduce inventory cost (b) on time delivery of
customer order (c) reduce safety stock cost (d)
maintain order cost.
13) When a relatively few materials items account for
a considerable portion of total inventory investment,
selective control is indicated. High value items would
be under tight control, while low-value items would
be under simple physical controls. Automatic control
refers to ordering when a materials record shows that
the balance on hand has dropped to the order point.
At this time, the quantity to order is automatic,
having been determined by balancing the cost to
order with the cost to carry inventory. Automatic
control is most effective in companies that use an
EDP system.
14) The key to control finished goods inventory is
accurate sale forecasting, with production schedules
communicated to producing departments.
15) (a) Manufacturing increase or decrease according
to customer orders (b) no extra cost of manufacturing
(c) only fixed cost expenditures in case of no order
for production (d) variable expenses decreases on
average when production level increases.
 Exercises

E-1

No of material to order for March:

Units

Estimated use of material B during 1st quarter: (w) 19325

Less:

Opening inventory Jan1 5600

Order of Jan 4100

Order of Feb 5100

Quantity to order for March 4525

Working

Estimated use of material B:

=Jan schedule + Feb schedule + March schedule + desired inventory

=5000 + 4950 + 5550 + (510075/100)

=19325 units

____________________________________________

E-2

Req:

1) Quantity to order units for March:

Units

Estimated use of material 20200

Less:

Opening inventory Jan 1 6000

Order of Jan 3800

Order of Feb 4600

Units to order for March 5800

Working

Estimated use of material

= 4800 + 5000 + 5600 + (600080/100)

= 20200 units

2) Inventory on March 1:
Units
Jan 1 Inventory 6000
Add: order of Jan & Feb
(3800+4600) 8400
14400
Less: usage forces + schedule for Jan & Feb
(4800+5000) 9800
March 1 inventory 4600
Inventory of March 31:
Inventory on March 1 4600
+ Order of March 5800
10400
_ Usage schedule for March 5600
Inventory March 31 4800
_________________________________
E-3
EOQ= 2 +
(a)

EOQ =2 100 5 55 15%

=1000 8.25

=121.21

= 11 units

_________________________________

(b)

EOQ = 2 3000 100 600

=6000000 600

=1000

= 100 units

______________________________________

(c)

EOQ = 2 2250 12 3 20%

=54000 0.6

=90000

= 300 units

____________________________________________

(d)

EOQ = 2 6750 20 12 25%

= 270000 3
 =90,000

= 300 units

____________________________________________________

(e)

EOQ = 2 12500 20 8 25%

= 500000 2

= 250,000

= 500 units

(1) Frequency of order:

= No of days in a year / No of orders per year

No of orders per year

= A-R/EOQ

(2) Frequency of order:

= 365/25
= 15 days
No of orders = 12500 / 500
= 25 orders
______________________________________________

(f)

(1) EOQ = 2 48000 10 0.04 + (20 10%)

= 960,000 2.4

=400,000

=632 units
Total annual inventory expenses / cost

= Annual ordering cost + annual carrying cost

Annual ordering cost

= Annual requirement cost per order/order quantity

Annual carrying cost

= (UCC+I)order quantity/2

Annual ordering cost

(4800010/800) 600

+Annual carrying cost

(0.4800/2) 160

Total annual inventory expenses 760

E-3

(g) EOQ = 2 5000 1000 8 20%

= 10000000 1.6

=6250000

= 2500 units

______________________________________________

(h) EOQ = 2 10000 80 0.40

=160,0000 0.40

=4000000
 = 2000 units

_______________________________________

(i)

1) EOQ = 2 12000 16 9 20%

=384,000 1.8

=213333.3333

= 462 units

_____________________________________

Frequency of orders:

= 365 / 26

= 14 days

No of orders = 12000 / 462

= 26 orders

____________________________________

EOQ = 2 8000 16 9 22%

=256,000 1.98

=129292.92

= 360 units

__________________________________________

(j) EOQ =2 500 6 10 25%

=6000 2.5
 =2400

= 49 units

_____________________________________

Total ordering cost

= 5006/49

= $ 61

Total carrying coat

= 2.549/2

= $ 61

Total ordering cost

= 5006/49+ (4910/100)

=5006/54

= $ 55

Total carrying cost

= 2.554/2

=$ 68

___________________________________________

(k) EOQ = 2 6000 300 50 20%

=3600000 10

=360000

= 600 units

Calculation of saving:
 Policy Amount Order No of Annual Annual Total Cost
ordering C.C
Req quantity Orders
cost

Company 6000 3000 2 600 15000 15600

policy

EOQ
6000 600 10 3000 3000 6000

Saving $9600

Annual Req = given

Order quantity = given

Annual ordering cost

= No of orders cost per order

Annual carrying cost

= O-Q/2(CC+I)

Total = Annual ordering cost + annual carrying coast

_____________________________________________

E-4

EOQ = 2 18000 50 3 40%

=1800000 1.2

=1500000
 = 1225 units

Company should decide that order quantity at which total cost is lower after
considering discount:

Amount Order No of Annual Annual Total Cost

ordering C.C
Req quantity Orders
cost

Discount 18000 2000 9 450 1200 1650

policy

EOQ
18000 1225 15 750 735 1485

Since no discount will be available in EOQ so discount cost will be part of EOQ.

T.C of EOQ = 1485 + Discount cost

= 1485 + 184

= $ 1669

Discount cost:

= 122535/100

= 184

T.C of EOQ is $ 1669, so company should buy in cost of 2000 units if 5% trade
discount is received.
__________________________________________________________-

Material
Inventory levels

1) Order point / levels

=Maximum requirement lead time
Or
= (Average requirement lead time) +safety stock
2) Minimum inventory level
=order point (average requirement lead time)
3) (Absolute) maximum level
=order point (maximum requirement lead time) + EOQ
4) Danger level
= Average requirement emergency time
5) Normal maximum inventory level
= Order point (average req l.t) + EOQ
6) Average inventory level
= (EOQ/2) + safety stock
7) Safety stock
= (maximum req -- Avg req) l.t
Or
Safety stock = average requirement lead time
______________________________________________
Combined stock out & safety stock carrying cost
Calculation table

Annual Prob. of Expected Cost per Annual Annual Annual

no of stock annual stock out stock out safety combined
orders out stock cost stock C.C Cost
 out

given given self given self self self

1 2 3 4 5 6 7

Expected annual stock out

= 1 2
Annual stock out cost
=34
Annual safety stock carrying cost
= safety stock level C.C for each safety stock unit
Annual combined cost
=5+6
Note:
Recommended safety stock is that at which annual combined cost is
minimum.
___________________________________________________________