Homework 5: Inventory Replenishment

Problem 1
Harvey’s Specialty Shop specializes in international gourmet foods. One of the items that Harvey
sells is a type of mustard which he purchases from an English company. The mustard costs
Harvey $10 a jar, and requires a six-month lead time for replenishment of stock. Harvey uses a
20 percent annual interest rate to compute holding costs. Harvey monitors the inventory of the
mustard continuously. Bookkeeping expenses for placing an order amount to about $50. During
the six-month replenishment lead time, Harvey estimates that he sells an average of 100 jars, but
there is substantial variation from one six-month period to the next. He estimates that the
standard deviation of demand during each six-month period is 25 jars. Assume that demand is
described by a normal distribution. Help Harvey to design a (Q, R) inventory control policy to
achieve 95% of service level of both type 1 and type 2, respectively.

Problem 2
AutoPart AG is a German supplier of car brakes. The company currently has a local factory and
a warehouse to serve its customers in Germany. In recent years, due to increasing competition of
imports from Asia and Eastern Europe, the company’s profit margin has been greatly squeezed.
To reduce cost and maintain profitability, AutoPart AG is considering outsourcing production to
a low-cost country while keeping its warehouse in Germany to serve its customers.

A logistics consultant is hired to help identify a destination for outsourcing. By reviewing

historical sales data, the consultant has found that the weekly demand for the brake follows a
normal distribution with mean 500 units and standard deviation of 200 units. AutoPart AG
adopts a (Q, R) policy for inventory control in the warehouse and sets the service level (Type-1)
at 95% (the corresponding z value is 1.645). The annual (52 weeks) inventory holding cost rate is
25%. After some screening, the consultant has narrowed down to China and Poland as two
candidate destinations for production outsourcing. Table 2 summarizes the key relevant factors
regarding these two alternatives.

Table: China vs. Poland as destinations of outsourcing

Total landed cost Ordering cost Replenish lead time
(dollars/unit) (dollars/order) (weeks)
China 15 25,000 N(9, 4)*
Poland 17 3,500 N(1, 0)
* N(9, 4) indicates that the replenish lead time from China follows a normal distribution with
mean value of 9 and variance of 4. Similar interpretation applies to N(1, 0).

a) Determine the ordering quantity and reorder point for the warehouse if the destination of
outsourcing is China or Poland, respectively.
b) From a total cost perspective, select the destination of outsourcing between China and
Poland. Justify your recommendation.
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Problem 3

A retail shop sells a type of electronic fans. The unit cost of an electronic fan is 100 dollars. The
monthly demand for the electronic fans follows a normal distribution with mean 800 units and
standard deviation of 200 units. Currently, the shop manages its inventory of the electronic fans
using a base stock policy. The inventory is replenished every 9 weeks. The lead time for order
delivery is 4 weeks. The cost of placing an order is 500 dollars. The annual inventory holding
cost rate is 25%.
(Note: conversion between time units 1 year = 12 months = 52 weeks; the z-value of a standard
normal distribution corresponding to 0.99 is 2.33).

(a) Under the base stock policy, what is the order-up-to level required to achieve a service
level (Type 1) of 99%? And, what is the annual inventory related cost (including ordering
cost and inventory holding cost) under the base stock policy?

(b) The warehouse is considering switching to a (Q, R) policy for inventory management.
Help the warehouse to design the (Q, R) policy and calculate the inventory related costs
(including ordering cost and inventory holding cost) under this new policy.

Problem 4

HomeAppliance sells a particular type of vacuum cleaner. The unit cost of a vacuum cleaner is
100 dollars. The monthly demand for the vacuum cleaners follows a normal distribution with
mean 800 units and standard deviation of 100 units. HomeAppliance purchases the vacuum
cleaners from a manufacturer in China. The lead time for order delivery is 2 weeks. The fixed
cost of placing an order is 500 dollars. The annual inventory holding cost rate for
HomeAppliance is 25%. HomeAppliance uses a base stock policy to manage the inventory of the
vacuum cleaners and aims to achieve a service level (type-I) of 99% (the z-value of a standard
normal distribution corresponding to 0.99 is 2.33). Due to scheduling constraint, HomeAppliance
can only place orders on a monthly or quarterly basis. In other words, orders can only be placed
at the beginning of a month or a quarter.

Assuming there are 4 weeks in a month, 3 months in a quarter, and 4 quarters in a year,
determine if HomeAppliance should replenish the inventory of the vacuum cleaner monthly or
quarterly. Show the steps of your calculations to justify your answer.

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Problem 5
Atec is a manufacturer of power supplies. A key component in a power supply is the PCB board.
Atec currently uses two different boards, PCB-1 and PCB-2, which are sourced from two
different suppliers. The unit purchasing prices of PCB-1 and PCB-2 are $25 and $24,
respectively. Atec keeps inventory of both boards. The weekly demands for PCB-1 ( D1 ) and
PCB-2 ( D2 ) follow normal distributions as in the following:
D1 ~ N ( µ1 , σ 1 ) , where
= µ1 500,
= σ 1 120
D2 ~ N ( µ2 , σ 2 ) , where
= µ2 550,
= σ 2 100
Further analysis reveals that D1 and D2 are negatively correlated with a coefficient of
correlation at ρ = −0.2 . The aggregate demand of PCB boards ( D1 + D2 ) also follows a normal
distribution:

D1 + D2 ~ N ( µ1+ 2 , σ 1+ 2 ) , where µ1+=

2 µ1 + µ2 , σ 1+ 2 = σ 12 + σ 22 + 2 ρσ 1 σ 2
(a) Currently Atec manages the inventories of PCB-1 and PCB-2 independently. For both
types of boards, the fixed ordering cost is $500/order, the replenishment lead time is 4
weeks, and the annual (52 weeks) inventory holding cost rate is 25%. The required
service level (type 1) is 95%, please help Atec to design a (Q, R) inventory control policy
for PCB-1 and PCB-2, respectively (the corresponding z value is 1.645).

(b) Engineers at Atec have recently come up with a universal design PCB-X, which can
perfectly substitute for both PCB-1 and PCB-2. PCB-X can be sourced from a single
supplier at $26.5/unit. Other factors being equal, what will be the ordering quantity and
reorder point for PCB-X under a (Q, R) policy to achieve the same service level at 95%?

(c) Investigate if there is any cost saving for Atec in substituting PCB-1 and PCB-2 with
PCB-X. Based on the result, advise whether Atec should make the substitution.