Practice Problems on Inventory Management – EOQ and Safety Stock

Additional Problems:

1. A provincial government uses massive quantities of computer printer paper, which it buys centrally.
The purchasing department calculates an economic order quantity based on an assumed carrying rate
of 30% per year. A box of printer paper costs $40, it costs $60 to process an order, and an annual
demand is for 36000 boxes of paper.

a) What is the economic order quantity? How much is the total inventory holding and ordering cost?

b) The buyer wishes to determine how sensitive the sum of inventory and ordering costs are to the
order quantity. Determine how the costs would change if the order quantity is 50% more than EOQ and
50% less than the EOQ quantity.

2. Sensitivity Analysis for EOQ:

a) What happens to cycle inventory if the demand rate increases?
b) What happens to lot sizes if setup costs decrease?
c) What happens to lot sizes if interest rates drop?

3. Safety Stock: Discrete Distribution

During the past fifty lead times, demands for a product have been as follows:

Demand Frequency
2 1
3 5
4 15
5 17
6 8
7 3
8 1

What safety stock should be kept to achieve the following indicated service level?
a) 99%, b) 95%, c) 90%, d) 50%, e) 25%

Additional Problems - Solutions:

2 DS 2(36000)( 60)
1. a. Qopt   = 600 boxes
H 0.3( 40)
Q D
Total cost of holding and ordering = H+ S = 600/2*12 + 36000/600*60 = $7200
2 Q
 Q D
b. If Q=900 units: H+ S = 900/2*12 + 36000/900*60 = $7800.
2 Q
So when Q is 50% higher, the total ordering and holding cost is 8.3% higher.

Q D
If Q=300 units: H+ S = 300/2*12 + 36000/300*60 = $9000
2 Q
So when Q is 50% lower, the total ordering and holding cost is 25% higher.

We can observe that under-ordering is more costly than over-ordering.

2. a. If demand rate increases, the economic order quantity increases. However, it only increases as the
square root of the demand.

b. If setup costs decrease then it is cheaper to produce in smaller lots and hence lot sizes should go
down. However, it only decreases as the square root of the setup cost.

c. If interest rates drop, then the cost of holding units in inventory goes down. It makes sense to hold
larger quantities, and, thus, produce larger lots.

3.
Demand Frequency Probability If ROP is Then, Service Level =
P(Lead time demand
<= ROP)
2 1 1 / 50 = .02 2 .02
3 5 5 / 50 = .10 3 .12
4 15 15 / 50 = .30 4 .42
5 17 17 / 50 = .34 5 .76
6 8 8 / 50 = .16 6 .92
7 3 3 / 50 = .06 7 .98
8 1 1 / 50 = .02 8 1
Total # data points: 50

Average demand during the lead time = 2*0.02 + 3*0.1 + 4*0.3 + 5*0.34 + 6*0.16 + 7*0.06 + 8*0.02 =
4.78 units.

a) If SL = 99%: ROP to assure 99% service level is 8 units. Thus, SS = 8–4.78 = 3.22 units.
b) 95%: ROP = 7 units; safety stock = 7-4.78 = 2.22 units
c) 90%: ROP = 6 units; safety stock = 6-4.78 = 1.22 units
d) 50%: ROP = 5 units; safety stock = 5-4.78 = 0.22 units
e) 25%: ROP = 4 units; safety stock = 4-4.78 = –0.78 units