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0BUAD 311 – Operations Management

Spring 2017 Final Exam Solution


Section A: Multiple Choice [18 points; 3 points each; no partial credit]

1. If we are to play eBeer game again, which one of the following will not help our performance?
a) We can identify other players in the supply chain and communicate with each other.
b) We have 5 players in a chain, instead of 4.
c) The delivery lead time decreases.
d) The information (order) lead time decreases.

Answer: b

2. Consider an optimization problem under which we maximize the objective function. If we add a
constraint to the original problem, the new optimal solution will be such that:
a) The new optimal objective value may be larger if the added constraint is a “less-than-or-
equal-to” type, and smaller if the added constraint is a “greater-than-equal-to” type.
b) The new optimal decision variables will be the same as before if the added constraint is
binding, and will change if the added constraint is non-binding.
c) The new optimal objective value will be smaller if the added constraint is non-binding.
d) None of the above is true.

Answer: d

3. Consider a continuous review inventory system, or (ROP, Q) system. If delivery lead time
increases, which of the following statements is false?
a) Q will increase.
b) ROP will increase.
c) Average inventory will increase.
d) Throughput time will increase.

Answer: a

4. If standard deviation of daily demand increases, which of the following statements is false?
a) Q will increase.
b) ROP will increase.
c) Average inventory will increase.
d) Throughput time will increase.

Answer: a

5. Which of the following is false?


a) In Littlefield game 2, we might use newsvendor model to make a final inventory ordering
decision right before day 218.

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b) Zara’s vertically integrated supply chain enables Zara to have lower costs than the
competitors have.
c) In the E-Beer game, the demand variability seen by the retailer is lower than the one seen
by the manufacturer.
d) Zara’s short design, manufacturing, and delivery lead times increase the accuracy of the
demand forecasts.

Answer: b

6. Trojan Airlines has been operating a flight with a single class fare. Suppose the denied boarding
cost is $600. From the historical records, number of passengers who does not show up in the
flight has the following distribution.

number of no-show-ups 0 1 2 3 4
Probability 0.25 0.25 0.2 0.2 0.1

Suppose that the manager, who took 311, computed that the optimal number of seats to
overbook is 1. Then, which of the following is correct about the ticket price?

a) The ticket price must be between $100 and $200.


b) The ticket price must be between $150 and $300.
c) The ticket price must be between $200 and $400.
d) The ticket price must be between $300 and $600.

Answer: b

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Section B: Problems

Q1. (40 points) You are making the inventory decisions for an international company. The product has a
forecasted daily demand with mean 365 and standard deviation 36.

You have two different options for procuring each product: from your factory in China (out-sourcing) or
procuring from your own factory in the United states (in-house). The following table provides the
relevant data for each type of procuring.

Outsourcing In-house
Setup cost $4,500 $50
Lead time 64 days 4 days
Procurement cost (per unit) $4.5 $5

The desired service level (irrespective of the procurement decision) is 97.5% and the cost of capital of
the firm is 20% (that is, the firm faces an annual interest rate of 20%). You may assume 365 days in a
year.

a) If we decide to produce in-house using an (ROP,Q) system.


1. (2 points) What is the optimal ordering quantity?
2𝑥365𝑥365𝑥50
𝑄=√ = 3650 𝑢𝑛𝑖𝑡𝑠
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2. (2 points) What is reorder point?

ROP=365 x 4 + 2 x √4 𝑥 36 = 1460 + 144 = 1604 units

3. (2 points) What is the average inventory level?

3650/2+144 = 1969 units

4. (2 points) What is the inventory turn?

365*365/1969 =67.66

5. (2 points) What is the annual holding cost?

1969 *1 = $1969

6. (2 points) What is the annual setup cost?

365*365/3650 * 50 = $1,825

7. (2 points) What is the annual total cost (including the purchase cost)?

1969+1825+365*365*5=$669,919

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b) If we decide to outsource using an (ROP,Q) system.
1. (2 points) What is the optimal ordering quantity?
2𝑥365𝑥365𝑥4500
𝑄=√ = 36500 𝑢𝑛𝑖𝑡𝑠
0.9

2. (2 points) What is reorder point?

ROP = 365 x 64 + 2 x √64 𝑥 36 = 23360 + 576 = 23,936 units

3. (2 points) What is the average inventory level?

36500/2+576 = 18826 units

4. (2 points) What is the inventory turn?

365*365/18826 = 7.08

5. (2 points) What is the annual holding cost?

18826* 0.9 = $16943.4

6. (2 points) What is the annual setup cost?

365*365/36500 * 4500 = $16425

7. (2 points) What is the annual total cost (including the purchase cost)?

16943.4+16425+365*365*4.5=$632,880.9

c) We now need to decide on our optimal procurement strategy. That is, we need to decide
whether to produce each product in-house or to outsource in order to minimize total cost.
1. (4 points) Draw a decision tree that corresponds to your decision problem.

632880.9

669919

2. (4 points) What is your optimal procurement strategy?

Outsourcing.

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d) (4 points) Suppose that we realize that the standard deviation of the demand uncertainty is
much less than what we have originally estimated, will you change your procurement strategy?
Explain your answer.

The safety stock level is proportional to the standard deviation and outsourcing strategy has a
much higher safety stock level compared to the in-house strategy (4:1). As a result, even
outsourcing strategy has low procurement cost (and lower per unit holding cost) (0.9:1), the
reduced demand standard deviation would help outsourcing strategy more and we should
continue use outsourcing. In general, in-house production is reserved for high uncertainty items.

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Q2. (42 points) Trojan Crafts makes hand-crafted decorations for the holiday season each year. It only
offers two designs: one is the classic set, and the other is the so-called season’s set which changes from
year to year. The price of the classic set is $300 and the price of the season’s set is $450. The demand
has been reasonably strong and Trojan Crafts is limited by its workforce because training additional
employees is costly. Currently, Trojan Crafts employs 3 assemblers and 7 painters. To produce a set,
Trojan Crafts first purchases the pre-made parts from a vendor. The cost of the pre-made parts is $50 for
both designs. The pre-made parts will go through a preparation chamber for heat-treatments, and then
an assembler will assemble the parts, and finally a painter would paint the product. The preparation
chamber can treat 60 sets (either classic or seasonal) in 24 hours and it runs for 365 days a year. One
assembler can assemble a classic set in 20 minutes and a season’s set in 40 minutes. One painter can
paint a classic set in 60 minutes and a season’s set in 80 minutes. Both the assemblers and painters work
250 days a year and 8 hours a day. Trojan Crafts would also like to produce at least 2400 seasonal sets
per year because it would like to satisfy the collectors’ demand. After learning that you have completed
the study of 311, Trojan Crafts asks you to help them figure out the optimal planning.

Write down a linear optimization formulation for Trojan Crafts.

a. (3 points) What are the decision variables?

𝑥 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑐𝑙𝑎𝑠𝑠𝑖𝑐 𝑠𝑒𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟


𝑦 = 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑠𝑒𝑎𝑠𝑜𝑛𝑎𝑙 𝑠𝑒𝑡𝑠 𝑝𝑟𝑜𝑑𝑢𝑐𝑒𝑑 𝑖𝑛 𝑎 𝑦𝑒𝑎𝑟

b. (3 points) What is the objective function?

Maximize (300 − 50)𝑥 + (450 − 50)𝑦

c. (6 points) What are the constraints?

Heat-treatment capacity: 𝑥 + 𝑦 ≤ 60 × 365 = 21,900


Assembly capacity: 20𝑥 + 40𝑦 ≤ 60 × 8 × 250 × 3 = 360,000
Painting capacity: 60𝑥 + 80𝑦 ≤ 60 × 8 × 250 × 7 = 840,000
Seasonal demand production: 𝑦 ≥ 2400
Non-negativity constraints: 𝑥, 𝑦 ≥ 0

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Answering the following question based on the sensitivity report:
Variable Cells
Final Reduced Objective Allowable Allowable
Cell Name Value Cost Coefficient Increase Decrease
$B$5 6000 0 250 50 50
$C$5 6000 0 400 100 66.66666667

Constraints
Final Shadow Constraint Allowable Allowable
Cell Name Value Price R.H. Side Increase Decrease
$B$10 12000 0 21900 1E+30 9900
$B$11 360000 5 360000 60000 48000
$B$12 840000 2.5 840000 144000 120000
$B$13 6000 0 2400 3600 1E+30

d. (4 points) What is the annual profit based on the sensitivity report?

250 × 6000 + 400 × 6000 = $3,900,000

e. (2 points) The engineer finds a way to shorten the heat-treatment time from 24 hours to 20 hours
with an annual maintenance cost of 1000 dollar. Should Trojan Crafts implement it?

No, because the heat-treatment is not used with full capacity (12,000 < 21,900). We do not need
to invest in heat-treatment.

f. (2 points) The vendor is notifying Trojan Crafts that the cost of pre-made parts will increase from 50
to 60. Do we need to resolve the linear optimization to find the optimal solution?

Yes, because under this change both objective coefficients decrease by 10 simultaneously.
Sensitivity report can be used for decision making only if one parameter changes.

g. (3 points) The salary and benefit of a painter would cost Trojan Crafts $10,000 monthly. The new
painter typically only stays 1 year with Trojan Crafts, should we try to hire one more painter?

Annual cost of the new painter to us = 12 × 10,000 = $120,000. The new painter will increase the
painting capacity by 60 × 8 × 250 = 120,000 𝑚𝑖𝑛𝑢𝑡𝑒𝑠, which is within allowable increase. The
optimal profit will increase by $2.5/𝑚𝑖𝑛 × 120,000 𝑚𝑖𝑛 = $300,000, which is greater than
$120,000. Hence, we should try to hire one more painter.

h. (3 points) Continue with information in g. You realize that it takes three months and cost $30,000 to
train a new painter, who typically only stays 9 months with Trojan Crafts (including the three
months of paid training), should we try to hire one more painter given that the new painter will
effectively work 125 days in 6 months and 8 hours a day?

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Cost of the new painter to us = 30,000 + 9 × 10,000 = $120,000. The new painter will increase
the painting capacity by 60 × 8 × 125 = 60,000 𝑚𝑖𝑛𝑢𝑡𝑒𝑠, which is within allowable increase. The
optimal profit will increase by $2.5/𝑚𝑖𝑛 × 60,000 𝑚𝑖𝑛 = $150,000, which is great than $120,000.
Hence, we should try to hire one more painter.

After looking at the historic transaction record, you notice that while the price of the classic set has been
stable, the price of the seasonal set varies over the year, depending on the trend as well as the
competitors’ seasonal offering. The historic price data of the past five years is listed in the table below.
480
420
450
450
420

i. (6 points) Develop a three-period moving average forecast for the current year.

Year Price Forecast AD


1 480
2 420
3 450
4 450 450 0
5 420 440 20
6 440

Price forecast for the current (sixth) year is $440.

j. (6 points) What is the MAD and standard deviation of this forecast?

𝑀𝐴𝐷 = (0 + 20)⁄2 = 10
Forecast standard deviation is 1.25𝑀𝐴𝐷 = 1.25 × 10 = 12.5

k. (4 points) You are concerned whether the price uncertainty would impact the optimal product
planning analyzed earlier. After a much-detailed analysis, you believe that the price of the current
year would have a mean of 440 and a standard deviation of 10. You also understand that with 95%
chance, the price would fall between two standard deviations below the mean and two standard
deviations above the mean and you believe that you don’t need to concern about the prices beyond
this range. Should Trojan Crafts change its optimal product planning?

We solved the LOP with the price $450. We consider the prices between (440 − 20, 440 + 20) =
(420, 460). This range is 30 below and 10 above $450, which are both within the allowable range.
Hence, the LOP optimal solution will not change and so we do not need to change the product
planning.