Production Planning &

Control:
Inventory (Phase B)
 Learning Outcomes
1. Identify or Define:
Economic Order Quantity (EOQ) Model
Production Order Quantity (POQ) Model
 Inventory Models

Fixed order-quantity models Help answer the

inventory planning
Economic order quantity questions!
Production order quantity
Quantity discount

Probabilistic models
Fixed order-period models

1984-1994
T/Maker Co.
EOQ
 EOQ Assumptions

Known and constant demand

Known and constant lead time
Instantaneous receipt of material
No quantity discounts
Only order (setup) cost and holding cost
No stockouts
 Inventory Usage Over Time

Order quantity = Q Usage Rate

(maximum Average
inventory level) Inventory
(Q*/2)
Inventory Level

Minimum
inventory 0
Time
 EOQ Model
How Much to Order?
Annual Cost

Minimum
total cost

Order (Setup) Cost Curve

Optimal Order quantity

Order Quantity (Q*)
 Why Holding Costs Increase

More units must be stored if more are ordered

Purchase Order Purchase Order

Description Qty. Description Qty.
Microwave 1 Microwave 1000

Order quantity Order quantity

 Why Order Costs Decrease
Cost is spread over more units
Example: You need 1000 microwave ovens
1 Order (Postage $ 0.33) 1000 Orders (Postage $330)

Purchase Order PurchaseOrder

Purchase Order
Description
PurchaseOrder
OrderQty.
Description
Purchase
Qty. Description Qty.
Qty.
Microwave 1000 Description
Microwave Qty. 11
Description
Microwave
Microwave
Microwave 11
Order quantity
 Deriving an EOQ

1. Develop an expression for setup or ordering

costs
2. Develop an expression for holding cost
3. Set setup cost equal to holding cost
4. Solve the resulting equation for the best order
quantity
 EOQ Model
When To Order
Inventory Level
Optimal Average
Order Inventory
Quantity (Q*/2)
(Q*)

Reorder
Point
(ROP)

Time
Lead Time
 EOQ Model Equations
Optimal Order Quantity 2 D S
, Q* =
H
Expected Number of Orders , N =
D
Q*
Expected Time Between Orders Working Days / Year
, T =
N
D D = Demand per year
d =
Working Days / Year S = Setup (order) cost per order
H = Holding (carrying) cost
ROP = d L d = Demand per day
L = Lead time in days
Total cost

D Q
TC = S + H
Q 2

D = Demand per year

Q = Optimal order quantity
S = Setup (order) cost per order
H = Holding (carrying) cost
 The Reorder Point (ROP) Curve
Q*

Slope = units/day = d
Inventory level (units)

ROP
(Units)

Time (days)
Lead time = L
 EOQ Model Problem 1
ABC Company supplies needles to hospitals.
The annual demand is 1,000 units.
The setup or ordering cost is $10 per order.
The holding cost per unit per year is $0.50
Question: Determine the optimal number of units per order.

2 DS 2(1,000)(10)
Q* = = = 40,000 = 200 units
H 0.5
 EOQ Model Problem 2
D = 1,000 units per year.
S = $10 per order, H = $0.50 per unit per year.
Total working day per year = 250.
Question: Determine the optimal number of orders(N) per year and the
expected time between orders(T).

2 DS 2(1,000)(10)
Q* = = = 40,000 = 200 units
H 0.5

Demand 1,000
N= = = 5 orders per year
Order quantity 200

working days 250

T= = = 50 days between orders
number of orders 5
 EOQ Model Problem 3
D = 1,000 units per year.
S = $10 per order, H = $0.50 per unit per year.
Question: Determine the optimal total annual inventory cost.

2DS
2 DS 2(1,000)(10)
Q* = = = 40,000 = 200 units
H 0.5

D Q 1,000 200
TC = S+ H = ($10) + ($0.50)
Q 2 200 2

= $50 + $50 = $100

 EOQ Model Problem 4
D = 8,000 units per year, working days = 250 per year.
On average, delivery of an order takes 3 working days.
Calculate the reorder point.

D 8,000
Demand per day, d = = = 32 units
working day per year 250

unit
Reorder point, ROP = d L = 32 3 day = 96 unit
day

Thus, when inventory stock drops to 96, an order should be placed.

The order will arrive 3 days later, just as the firm' s stock is depleted.
POQ
Production Order Quantity Model
Answers how much to order and when to order
Allows partial receipt of material
Other EOQ assumptions apply
Suited for production environment
Material produced, used immediately
Provides production lot size

Lower holding cost than EOQ model

 POQ Model Inventory Levels
Inventory Level
Inventory level with no demand

Production Max. Inventory

Portion of Cycle Q(1- d/p)
Q*

Time
Supply Supply Demand portion of cycle
Begins Ends with no supply
Run Time

Cycle Time
Reasons for Variability in Production

Most variability is caused by waste or by poor

management. Specific causes include:

employees, machines, and suppliers produce units that do
not conform to standards, are late or are not the proper
quantity

inaccurate engineering drawings or specifications

production personnel try to produce before drawings or
specifications are complete

customer demands are unknown
 POQ Model Inventory Levels
Inventory Level
Inventory level with no demand

Production Max. Inventory

Portion of Cycle Q(1-- d/p)
Q(1
Q*

Time
Supply Supply Demand portion of cycle
Begins Ends with no supply
 POQ Model Equations

= Q* = 2*D*S
Optimal Order Quantity
p
( )
H* 1 -
d
p

Maximum inventory level = Q* ( 1 -

d
p )
D D = Demand per year
Setup Cost = * S
Q S = Setup cost
H = Holding cost
Holding Cost = 0.5 * H * Q
( )
1-
d
p
d = Demand per day
p = Production per day
 Example1
Demand = 1,000 units per year, Setup = $10, Holding = $0.50 per unit per
year, average daily demand = 4 units.
Optimum production rate = 8 units per day. Total working days per year = 250
Calculate the optimum number of units per order.

D = 1000 units, S = $10, H = $0.50, p = 8 units perday, d = 4 units perday

2 DS 2(1,000)(10)
Q*p = =
d 4
H [1 ( )] 0.5[1 ( )]
p 8

20,000
= = 80,000 = 282.8 283 units
0.5(0.5)
 Example 2
XYZ Computer Company uses 1,000 transistors each month for its computers assembly. The
unit cost of each transistor is $10, and the cost of carrying one transistor in inventory for
a year is $3. Ordering cost is $30 per order. Compute:
(a) The optimal order quantity.
(b) The expected number of orders placed each year.
(c) The expected time between orders. (Assume 200 working day per year)

D = 1000(12) units, S = $30, H = $3

2 DS 2(1,000 12)(30)
(a ) Q* = = = 489.9 490 units
H 3

D 12,000
(b) N = *
= = 24.5 25 orders per year
Q 490

working day per year 200

(c) Time between orders, T = = = 8 days
N 25
 Example 3
Annual demand for notebook binders at Salina Stationery Shop is
10,000 units. The shop is operating 300 days per year and finds that
deliveries from supplier generally takes 5 working days. Calculate
the reorder point for the notebook binders.

L = 5 days

10 ,000
d= = 33 .33 units per day
300

unit
ROP = d L = 33 .33 5 day = 166 .7 units
day

Salina Stationery Shop should reorder wh en her stock reaches 167 units
 Example 4
Leonard Presby Inc. has an annual demand rate of 1,000 units but can
produce at average production rate of 2,000 units. Setup cost is
$10; carrying cost is $1. What is the optimal number of units to be
produced each time.

D = 1000 units, S = $10, H = $1, p = 2,000 units peryear, d = 1,000 units peryear

2 DS 2(1,000)(10)
Q*p = =
d 1,000
H [1 ( )] 1[1 ( )]
p 2,000

20,000
= = 40,000 = 200 units
0.5
CLASS END