10

Inventory Models

MULTIPLE CHOICE

1. Inventory
a. is held against uncertain usage so that a supply of items is available if needed.
b. constitutes a small part of the cost of doing business.
c. is not something that can be managed effectively.
d. All of the alternatives are correct.
ANSWER: a
TOPIC: Introduction

2. Inventory models in which the rate of demand is constant are called

a. fixed models.
b. deterministic models.
c. JIT models.
d. requirements models.
ANSWER: b
TOPIC: Introduction

3. The EOQ model

a. determines only how frequently to order.
b. considers total cost.
c. minimizes both ordering and holding costs.
d. All of the alternatives are correct.
ANSWER: b
TOPIC: EOQ model

4. Which cost would not be considered part of a holding cost?

a. cost of capital
b. shipping cost
c. insurance cost
d. warehouse overhead
ANSWER: b
TOPIC: EOQ model

1
2 Chapter 10 Inventory Models

5. For inventory systems with constant demand and a fixed lead time,
a. the reorder point = lead-time demand.
b. the reorder point > lead-time demand.
c. the reorder point < lead-time demand.
d. the reorder point is unrelated to lead-time demand.
ANSWER: a
TOPIC: When-to-order decision

6. Safety stock
a. can be determined by the EOQ formula.
b. depends on the inventory position.
c. depends on the variability of demand during lead time.
d. is not needed if Q* is the actual order quantity.
ANSWER: c
TOPIC: EOQ model

7. The economic production lot size model is appropriate when

a. demand exceeds the production rate.
b. there is a constant supply rate for every period, without pause.
c. ordering cost is equivalent to the production setup cost.
d. All of the alternatives are correct.
ANSWER: c
TOPIC: Economic production lot-size model

8. The maximum inventory with backorders is

a. Q
b. Q-S
c. S
d. (Q - S) / 2
ANSWER: b
TOPIC: Inventory model with planned shortages

9. Annual purchase cost is included in the total cost in

a. the EOQ model.
b. the economic production lot size model.
c. the quantity discount model.
d. all inventory models.
ANSWER: c
TOPIC: Quantity discounts for the EOQ model

10. In the single-period inventory model with probabilistic demand,

a. surplus items are not allowed to be carried in future inventory.
b. co = cu .
c. probabilities are used to calculate expected losses.
d. All of the alternatives are correct.
ANSWER: c
TOPIC: Single-period inventory model

11. For the inventory model with planned shortages, the optimal order quantity results in
a. annual holding cost = annual ordering cost.
b. annual holding cost = annual backordering cost.
c. annual ordering cost = annual holding cost + annual backordering cost.
d. annual ordering cost = annual holding cost – annual backordering cost.
ANSWER: c
TOPIC: Inventory model with planned shortages
Chapter 10 Inventory Models 3

12. The definition of service level used in this chapter is

a. the percentage of all demand that can be satisfied from inventory.
b. the percentage of all order cycles that do not experience a stockout.
c. the percentage of demand during the lead-time period that can be satisfied from inventory
d. None of the alternatives is correct.
ANSWER: b
TOPIC: Inventory models with probabilistic demand

13. Periodic review inventory systems

a. are less subject to stockouts than corresponding continuous review systems.
b. require larger safety stock levels than corresponding continuous review systems.
c. have constant order quantities.
d. make the coordination of orders for multiple products more difficult.
ANSWER: b
TOPIC: Periodic review model with probabilistic demand

14. Inventory position is defined as

a. the amount of inventory on hand in excess of expected demand.
b. the amount of inventory on hand.
c. the amount of inventory on hand plus the amount of inventory on order.
d. None of the alternatives is correct.
ANSWER: c
TOPIC: The when-to-order decision

15. A firm that is presently using the Economic Order Quantity model and is planning to switch to the
Economic Production Lot-Size model can expect
a. the Q* to increase
b. the maximum inventory level to increase.
c. the order cycle to decrease.
d. annual holding cost to be less than annual setup cost.
ANSWER: a
TOPIC: Economic production lot-size model

16. Which of the following is not implied when average inventory is Q/2, where Q is the order quantity?
a. An entire order quantity arrives at one time.
b. The previous order quantity is entirely depleted when the next order arrives.
c. An order quantity is depleted at a uniform rate over time.
d. Backorders are permitted.
ANSWER: d
TOPIC: EOQ model

17. For the EOQ model, which of the following relationships is incorrect?
a. As the order quantity increases, the number of orders placed annually decreases.
b. As the order quantity increases, annual holding cost increases.
c. As the order quantity increases, annual ordering cost increases.
d. As the order quantity increases, average inventory increases.
ANSWER: c
TOPIC: EOQ model
4 Chapter 10 Inventory Models

18. The objective of the EOQ with quantity discounts model is to

a. determine the minimum order quantity required for the maximum discount.
b. balance annual ordering and holding costs.
c. minimize annual purchase cost.
d. minimize the sum of annual carrying, holding, and purchase costs.
ANSWER: d
TOPIC: Quantity discounts for the EOQ model

TRUE/FALSE

1. To be considered as inventory, goods must be finished and waiting for delivery.

ANSWER: False
TOPIC: Introduction

2. When demand is independent, it is not related to demand for other components or items produced by the
firm.
ANSWER: True
TOPIC: Introduction

3. Constant demand is a key assumption of the EOQ model.

ANSWER: True
TOPIC: EOQ model

4. In the EOQ model, the average inventory per cycle over many cycles is Q/2.
ANSWER: True
TOPIC: EOQ model

5. The single-period inventory model is most applicable to items that are perishable or have seasonal
demand.
ANSWER: True
TOPIC: When-to-order decision

6. The time between placing orders is the lead time.

ANSWER: False
TOPIC: When-to-order decision

7. If the optimal production lot size decreases, average inventory increases.

ANSWER: True
TOPIC: Economic production lot-size model

8. If an item's per-unit backorder cost is greater than its per-unit holding cost, no intentional shortage should
be planned.
ANSWER: False
TOPIC: Inventory model with planned shortages

9. When quantity discounts are available, order an amount from the highest discount category.
ANSWER: False
TOPIC: Quantity discounts for the EOQ model

10. When there is probabilistic demand in a multi-period model, the inventory level will not decrease
smoothly and can fall below 0.
Chapter 10 Inventory Models 5

ANSWER: True
TOPIC: Order quantity, reorder point model with probabilistic demand

11. In the periodic review model, the order quantity at each review period must be sufficient to cover demand
for the review period plus the demand for the following lead time.
ANSWER: True
TOPIC: Periodic review model with probabilistic demand

12. Periodic review systems require smaller safety stock levels than corresponding continuous review
systems.
ANSWER: False
TOPIC: Periodic review model with probabilistic demand

13. The cost of overestimating demand is usually harder to determine than the cost of underestimating
demand.
ANSWER: False
TOPIC: Single-period inventory model with probabilistic demand

14. The terms “inventory on hand” and “inventory position” have the same meaning.
ANSWER: False
TOPIC: The when-to-order decision

15. The EOQ model is insensitive to small variations or errors in the cost estimates.
ANSWER: True
TOPIC: Sensitivity analysis for the EOQ model

SHORT ANSWER

1. What are the two most critical behaviors of an inventory system you need to recognize in order to apply
the best model?
TOPIC: Introduction

2. What compromise must be made in the how-much-to-order decision?

TOPIC: How-much-to-order decision

3. Derive and explain the total cost expression for the EOQ model.
TOPIC: EOQ model

4. What could be meant by service level? Why is a clear understanding of this term important?
TOPIC: When-to-order decision

5. Explain the difference between a periodic and a continuous review system.

TOPIC: Periodic-review model with probabilistic demand

PROBLEMS

1. Show the total cost expression and calculate the EOQ for an item with holding cost rate 18%, unit cost
$8.00, annual demand of 40000, and ordering cost of $48.
TOPIC: EOQ model
6 Chapter 10 Inventory Models

2. Demand for a popular athletic shoe is nearly constant at 800 pairs per week for a regional division of a
national retailer. The cost per pair is $54. It costs $72 to place an order, and annual holding costs are
charged at 22% of the cost per unit. The lead time is two weeks.

a. What is the EOQ?

b. What is the reorder point?
c. What is the cycle time?
d. What is the total annual cost?
TOPIC: EOQ model

3. The Super Discount store (open 24 hours a day, every day) sells 8-packs of paper towels, at the rate of
approximately 420 packs per week. Because the towels are so bulky, the annual cost to carry them in
inventory is estimated at $.50. The cost to place an order for more is $20 and it takes four days for an
order to arrive.

a. Find the optimal order quantity.

b. What is the reorder point?
c. How often should an order be placed?
TOPIC: EOQ model

4. An office supply store open 5 days a week must determine the best inventory policy for boxes of copier
paper. Weekly demand is nearly constant at 250 boxes and when orders are placed, then entire shipment
arrives at once. The cost per box is $22 and the inventory holding cost is 30%. Orders are placed at a
cost of $40 each, including preparation time and communication charges, and the lead time is 2 days.

a. Find the optimal order quantity.

b. What is the reorder point?
c. How often should an order be placed?
d. What is the cycle time?
TOPIC: EOQ model

5. Zip Games purchases blank 3.5-inch disks onto which it copies its software for sale through its mail order
operation. A disk costs Zip $.20. Processing an order for more disks cost $15. Zip uses 60000 disks
annually, and the company has a 25% cost of capital.

a. Find the optimal order quantity.

b. How many orders are placed annually?
c. How frequently will orders be placed?
TOPIC: EOQ model

6. Kellam Images prints snack food bags on long rolls of plastic film. The plant operates 250 days a year.
The daily production rate is 6000 bags, and the daily demand is 3500 bags. The cost to set up the design
for printing is $300. The holding cost is estimated at 2 cents per bag.

a. What is the recommended production lot size?

b. If there is a five-day lead time to set up the line, what is the recommended reorder point?
TOPIC: Economic production lot-size model
Chapter 10 Inventory Models 7

7. Henderson Furniture sells reproductions of 18th century furniture. For a particular table, the assumptions
of the inventory model with backorders are valid.
D = 200 tables per year
I = 25% per year
C = $800 per table
Co = $80 per order
Cb = $50 per table per year
The store is open 250 days a year.

a. What are the values for order quantity and number of planned backorders that will minimize
total cost?
b. What is the maximum inventory?
c. What is the cycle time?
d. What is total cost?
TOPIC: Inventory model with planned shortages

8. The Tiernan Gallery and Art Museum distributes to its visitors a printed guide to its collections. There
are about 18000 visitors per year. Holding costs for the brochures are 20% and it costs $30 to place an
order with the printer. The printer has offered the following discount schedule:

Category Order Size Unit Cost

1 0 - 1499 $2.50
2 1500 - 2999 $2.20
3 3000 and over $1.80

How many brochures should be printed at a time?

TOPIC: Quantity discounts for the EOQ model

9. A weekly sports magazine publishes a special edition for the World Series. The sales forecast is for the
number of copies to be normally distributed with mean 800,000 copies and standard deviation 60,000
copies. It costs $.35 to print a copy, and the newsstand price is $1.95. Unsold copies will be scrapped.
How many copies should be printed?
TOPIC: Single-period inventory model with probabilistic demand

10. The Fitness Shop is considering ordering a special model exercise machine. Each unit will cost the shop
$410 and it will sell for $750. Any units not sold at the regular price will be sold at the year-end model
clearance for $340. Assume that demand follows a normal probability distribution with  = 20 and  =
6. What is the recommended order quantity?
TOPIC: Single-period inventory model with probabilistic demand

11. Daily demand for packages of five videotapes at a warehouse store is found to be normally distributed
with mean 50 and standard deviation 5. When the store orders more tapes, the ordering cost is $42 and
the orders take 4 days to arrive. Each pack of tapes costs $7.20 and there is a 24% annual holding cost
for inventory. Assume the store is open 360 days a year.

a. What is the EOQ?

b. If the store wants the probability of stocking out to be no more than 5%, and demand each day is
independent of the day before, what reorder point should be set?
c. How much of your reorder point in part b) is safety stock?
TOPIC: Order quantity, reorder point model with probabilistic demand

12. A gourmet food store uses a one-week periodic review system for its supply of coffee beans. There is a
five-day lead time for orders, and the store will allow two stockouts per year.
8 Chapter 10 Inventory Models

a. What is the probability of a stockout associated with each replenishment decision?

b. What is the replenishment level if demand during the review and lead-time periods is normally
distributed with mean 120 pounds and standard deviation 8 pounds?
c. How many pounds of beans should be ordered if there are 42 pounds of beans on hand?
TOPIC: Periodic-review model with probabilistic demand

13. Chez Paul Restaurant orders special Styrofoam "doggy bags" for its customers once a month and lead
time is one week. Weekly demand for doggy bags is approximately normally distributed with an average
of 120 bags and a standard deviation of 25. Chez Paul wants at most a 3% chance of running out of
doggy bags during the replenishment period. If he has 150 bags in stock when he places an order, how
many additional bags should he order? What is the safety stock in this case?
TOPIC: Periodic-review model with probabilistic demand

SOLUTIONS TO PROBLEMS

1. TC = (1/2)Q(.18)(8) + 40000(48)/Q
Q* = 1633

2. a. Q* = 710.1
b. r = 1600
c. T = 710.1/800 = .8876 weeks or .8876(7) = 6.2 days
d. TC = .5(710.1)(.22)(54) + (41600/710.1)(72) = 8435.99

3. a. Q* = 1322
b. r = (60)(4) = 240
c. T = 365(1322)/21840 = 22 days

4. a. Q* = 397
b. TC = .5(397)(6.6) + (13000/397)(40) = 2620
c. r = 100
d. Cycle = 7.94 days

5. a. Q* = 6000
b. 10 orders placed annually
c. every 36.5 days

6. a. Q* = 250,998
b. 17500

7 a. Q* = 28.28
S* = 28.28(200/250) = 22.62
b. 28 - 23 = 5 tables
c. Cycle time = (28/200)250 = 35 days
d. TC = 89.29 + 571.43 + 473.32 = 1134.04 (using whole numbers of tables for Q and S)
d
8. EOQ3 = 1732.1 (raise to 3000)
EOQ2 = 1566.7 (feasible, so no reason to compute EOQ 1)

TC(1566.7) = 689.35
TC(3000) = 720.00
Chapter 10 Inventory Models 9

So the gallery should order 1566.7 or 1567 brochures at a time.

9. P(demand < Q*) = 1.6/1.95 = .8205

Q* = 800000 + .92(60000) = 855,200

10. cu = 340, co = 70
P(demand < Q*) = .8293
Q* = 20 + .95(6) = 25.7 so order 26

11. a. Q* = 866.025
b. DDLT is N(200,10)
r = 200 + 1.645(10) = 216.45
c. 16.45

12. a. 2/52 = .0385

b. M = 120 + 1.77 (8) = 134.16
c. 134 - 40 = 94

13. Order 555 doggy bags. Safety stock is 105 bags.