INVENTORY MODELS

UNIT - 3
Introduction
• Inventory - a physical stock of material or goods or commodities or
other economic resources that are stored or reserved or kept in stock
for smooth and efficient running of future affairs of an organization at
the minimum cost of funds or capital blocked in the form of materials
or goods (Inventories).
• To meet the objectives of maximum customer service with minimum
investment and efficient (low cost) plant operation is termed as
Inventory control.
 COSTS ASSOCIATED WITH INVENTORY
• Purchasing cost is the price per unit of an inventory item.
• At times the item is offered at a discount if the order size exceeds a certain amount,
which is a factor in deciding how much to order.
• Setup cost represents the fixed charge incurred when an order is placed
regardless of its size.
• Increasing the order quantity reduces the setup cost associated with a given demand,
but will increase the average inventory level and hence the cost of tied capital.
• On the other hand, reducing the order size increases the frequency of ordering and
the associated setup cost. An inventory cost model balances the two costs.
• Holding cost represents the cost of maintaining inventory in stock.
• It includes the interest on capital and the cost of storage, maintenance, and handling.
• Shortage cost is the penalty incurred when we run out of stock.
• It includes potential loss of income and the more subjective cost of loss in customer's
goodwill.
TYPES OF INVENTORY MODELS

Deterministic and static with time

Deterministic and dynamic with time

Probabilistic and stationary over time.

Probabilistic and non-stationary over time.

• If the average monthly demand is "approximately" constant for all
months and V is reasonably small ( < 20%), then the demand may be
considered deterministic and static, with its value equal to the
average of all monthly demands.
• If the average monthly demand varies appreciably among the
different months but V remains reasonably small, then the demand is
considered deterministic but dynamic.
• 3. If, in Case 1, V is high (>20%) but approximately constant, then the
demand is probabilistic and stationary.
• 4. The only remaining case is the probabilistic nonstationary demand
which occurs when the means and coefficients of variation vary
appreciably over time.
 STATIC ECONOMIC-ORDER-QUANTITY (EOQ)
MODELS
• Purchase Model with Instantaneous Replenishment and without Shortages
• The simplest of the inventory models involves constant-rate demand with instantaneous
order replenishment and no shortage
D = Annual demand in units
C0 = Ordering cost/order
CC = Carrying cost/order
P = Purchase price / unit
Q = Order size
Total Inventory Cost/year = Cost of Ordering/year + Cost of carrying/year + Purchase cost/year
Indicates Present
Order
D Q
No. of Orders / year = Average Inventory =
Q 2

D 2Co .D
Cost of Ordering/year = .Co Optimal Order size , Q* 
Q Cc

Q
Cost of carrying/year = .Cc D
2 Total no. of Orders / year =
Q*
Purchase Cost/year = D. p Q*
Time between Orders =
D
The annual demand of an item in the stores of a foundry is 9000 units. Its annual carrying cost
is 15% of the purchase price of the item/year, where purchase price is Rs 20 per unit. The
ordering cost is Rs 15/order. Presently the order size of the item is the average monthly
demand of that item. Find the economic order quantity and compare its cost with the present
ordering system and find the corresponding cost average if exists.
D 9000
Given : Cost of Ordering/year = .Co  15  450
Q* 300
D  9000 / year
Co  Rs 15 / order Q* 300
Cost of carrying/year = .Cc   3  450
p  Rs 20 / unit 2 2
Cc  0.15  20  Rs 3 / unit / year Purchase Cost/year = D. p  9000  20  180000
Solution :
Optimal Inventory
Total Cost/year = 180900/year
cost
2Co .D
Q* 
Cc
2 15  9000
  300 units
3
Present Order size = 9000 / 12 = 750 units

D 9000
Cost of Ordering/year = .Co  15  180
Q 750
Q 750
Cost of carrying/year = .Cc   3  1125
2 2 Total savings for optimal order
= 181305 – 180900
Purchase Cost/year = D. p  9000  20  180000
= Rs 405 / year

Total Cost/year = 1,81,305/year Present Inventory

cost
The purchase manager currently follows EOQ policy of ordering for an item in the stores of his
company. The annual demand of the item is 1,600 units. Its carrying cost is 40% of the unit cost
where the unit cost is Rs 400. The ordering cost is Rs 500/order. Recently, the vendor supplying
that item gives a discount of 10% in its unit cost if the order size is minimum of 500 units .
(a) Find EOQ and the corresponding total cost/year.
(b) Check whether the discount offer given by the vendor can be considered by the purchase
manager.
2  500 1600
Given :   100 units
160
D  1600 / year D 1600
Cost of Ordering/year = .Co   500  8000
Co  Rs 500 / order Q* 100
p  Rs 400 / unit
Q* 100
Cc  0.4  400  Rs 160 / unit / year Cost of carrying/year = .Cc  160  8000
2 2
Solution :
Purchase Cost/year = D. p  1600  400  640000
2Co .D
Q* 
Cc Total Cost/year = 6,56,000/year Optimal Inventory
cost
Present Order size = 500 units

Purchase cost with discount = 400 – 40 = Rs 360

Purchase Cost/year = D. p  1600  360  576000

Q The discount offer is feasible to consider.

Cost of carrying/year = .Cc
2
500
  (0.4  360)  36000
2
D 1600
Cost of Ordering/year = .Co   500  1600
Q 500

Total Cost/year = 613600/year Present Inventory

cost
Purchase Model with Instantaneous Replenishment
and with Shortages
D = Annual demand in units
C0 = Ordering cost/order
CC = Carrying cost/unit/period
CS = Shortage cost/unit/period
P = Purchase price / unit
Q = Order size
Q1 = Maximum Inventory
Q2 = Maximum stock-out
t1 = Period of positive stock
t2 = Period of shortage
t = cycle time (t1 + t2)
 2Co .D Cs  Cc
Optimal Order size , Q*  .
Cc Cs

2Co .D Cs
Q1*  .
Cc Cs  Cc
Q1 *
Q2 *  Q *  Q1 * t1* 
D

Q* Q2 *
Time between Orders, t* = t2 * 
D D

D
Total no. of Orders / year =
Q*
The demand of a cola item in a store is 12,000 units per year. The carrying cost is Rs 2per unit
and the ordering cost is Rs 600 per order. The shortage cost is Rs 10 per unit per year. Find the
EOQ and the corresponding number of orders per year, the maximum inventory and
maximum shortage quantity.

Given :
D  12000 / year
Co  Rs 600 / order
Cc  Rs 2 / unit / year
Cs  Rs 10 / unit / year

Solution :
2Co .D (Cs  Cc )
Q*  .
Cc Cs

2  6000 12000 (10  2)

   2939.39 units
2 10
The demand of an item in a store is 18,000 units per year. The purchase price of
the item is Rs. 5 per unit and its carrying cost is Rs. 1.2 per unit per year and the ordering cost
is Rs. 400 per order. The shortage cost is Rs. 5 per unit per year. Find the EOQ and the
corresponding number of orders per year, the maximum inventory, maximum shortage
quantity and the total cost of the system.

Given :
D  18000 / year
p  Rs 5 / unit
Cc  Rs 1.2 / unit / year
Cs  Rs 5 / unit / year
Co  Rs 400 / order
Solution :
2Co .D (Cs  Cc )
Q*  .
Cc Cs

2  400 18000 (5  1.2)

   3858 units
1.2 5
Manufacturing Model without Shortages
An automobile factory manufactures a particular type of gear within the factory.
This gear is used in the final assembly. The particulars of this gear arc: demand rate, r =
14,000 units/ year, production rate, k = 35,000 units/year, set-up cost, C0 = Rs. 500 per set-up
and carrying cost, Cc = Rs. 15/unit/year. Find the economic batch quantity (EBQ) and cycle
time.
Given :
r  14000 / year
Co  Rs 500 / order
Cc  Rs 15 / unit / year
k  35000 / unit / year
Solution :
Manufacturing Model with Shortages
The demand for an item is 6000 units per year. Its production rate is 1000 units per
month. The carrying cost is Rs. 50/unit/year and the set-up cost is Rs. 2000 per set-up. The
shortage cost is Rs. 1000 per unit per year. Find various parameters of the inventory system.

Given :

Solution :