Prepared by: Jonathan Desenganio

TOPICS

Economic Order Quantity

Quantity Discounts
Re-ordering Point
Safety Stocks
 Inventory refers to the stocks or store of goods
INVENTORY CYCLE
Level of Inventory – decreases over time

Inventory 𝑸
𝟐
Receiving Order -
inventory replenish

Time
1st Cycle 2nd Cycle 3rd Cycle
Holding (Carrying) Cost – Cost to carry an Ordering Cost – Costs of ordering
item in inventory for a length of time,
usually a year.
Q
and receiving inventory.
INVENTORY CYCLE
Less
Larger Lesser
frequent
Inventory = ordering
order
and order cost
placement
placement
is less
larger larger
frequent =
inventory holding
cost

Inventory 𝑸
𝟐

Time
1st Cycle 2nd Cycle
 INVENTORY CYCLE
Q More
Higher
frequent
= ordering
order
cost
Smaller placement
Inventory
and order Lower
placement Smaller
= holding
is more inventory
cost
frequent
Inventory 𝑸
𝟐

Time
1st Cycle 2nd Cycle 3rd Cycle 4th Cycle 5th Cycle
Ordering
Cost
 Cost
Total Cost

Holding
Cost

Lowest
Total Cost

Ordering
Cost

EOQ Quantity
ECONOMIC ORDER QUANTITY How much to order?

D = Demand per time period (typically 1 year)

2𝐷𝑆 S = Ordering Cost
𝐸𝑂𝑄 =
𝐻 H = Holding Cost per time period (typically 1 year)

𝑇𝐶 = 𝐶𝑎𝑟𝑟𝑦𝑖𝑛𝑔 𝐶𝑜𝑠𝑡 + 𝑂𝑟𝑑𝑒𝑟𝑖𝑛𝑔 𝐶𝑜𝑠𝑡

D = Demand per time period (typically 1 year)
𝑄 𝐷
𝑇𝐶 = 𝐻 + 𝑆 S = Ordering Cost
2 𝑄 H = Holding Cost per time period (typically 1 year)
Q = Ordered Quantity
Example
A local distributor for a national tire company expects to sell
approximately 9,600 steel-belted radial tires of a certain size and tread
design next year. Annual carrying cost is $16 per tire, and ordering cost
is $75. The distributor operates 288 days a year. Calculate the EOQ
D = 9600
2𝐷𝑆 2(9600)(75)
H = $16 𝐸𝑂𝑄 = = = 90000 = 300 𝑡𝑖𝑟𝑒𝑠
S = $75 𝐻 16
𝑄 𝐷 300 9600
𝑇𝐶𝐸𝑂𝑄 = 𝐻+ 𝑆 = (16) + (75) = 4800
2 𝑄 2 300
301 9600
𝑇𝐶301 = 16 + 75 = 4800.03 𝑇𝐶299 = 4800.03
2 301
QUANTITY DISCOUNTS
EOQ Applications
Example
The maintenance department of a large hospital uses about 816 cases of
liquid cleanser annually. Ordering costs are $12, carrying costs are $4
per case a year. Determine the optimal order quantity and the total cost
given the price discounts for the number of orders on the table below.
Number of Orders of Price ($)
Cases
Less than 50 20
50 to 79 18
80 to 99 17
More than 100 16
Calculate EOQ
D = 816 Cases
2𝐷𝑆 2(816)(12)
H = $4 𝐸𝑂𝑄 = = = 4896 = 69.97 ≈ 70 𝐶𝑎𝑠𝑒𝑠
S = $12 𝐻 4

Number of Orders EOQ Adjusted EOQ (closest to Calculated EOQ)

Less than 50 70 49
50 to 79 70 70
80 to 99 70 80
100 and more 70 100
Calculate Total Cost for Each EOQ
Number of Orders of Cases Price ($) EOQ
D = 816 Cases Less than 50 20 49 𝑄 𝐷
H = $4 50 to 79 18 70 𝑇𝐶𝐸𝑂𝑄 = 𝑃𝐷 + 𝐻 + 𝑆
2 𝑄
S = $12 80 to 99 17 80
More than 100 16 100

49 816
𝑇𝐶49 = 20 816 + 4+ 12 = 16,617.84
2 49
70 816
𝑇𝐶70 = 18 816 + 4+ 12 = 14,967.89
2 70
80 816
𝑇𝐶80 = 17 816 + 4+ 12 = 14,154.40
2 80
100 816
𝑇𝐶100 = 16 816 + 4+ 12 = 13,353.92 EOQ = 100
2 100
Re-Ordering Point
When to Order?
 Lead Time – The time between placing order and receiving
of order
INVENTORY CYCLE

Q
d ROP = d x LT
d =Demand rate (units per day or week)
Inventory LT = Lead time in days or weeks
ROP
NOTE: Demand and lead time must be
expressed in the same time units.

Time
Lead Time
Safety Stocks
ROP application
 INVENTORY CYCLE
Demand Varies
Q
Assuming there is
d
more demand than
the expected
Inventory This indicates the
ROP inventory will be
depleted earlier than
expected,
resulting to early
stock-outs

ROP
+
SS Time

Safety
Stock
Lead Time
 INVENTORY CYCLE
Lead time Varies
Q Assuming that there is
d delay in receiving of
order than the
expected
Inventory
This indicates the
ROP inventory will be
depleted and it will
take longer to
replenish the
inventory

ROP
+
Expected
SS Time
Lead Time

Safety
Stock Longer Delayed
Lead Time Order
4 Cases in Re-ordering Point
Demand Lead Time Formula
1 Constant Constant 𝑅𝑂𝑃 = 𝑑 𝑥 𝐿𝑇 Safety Stocks
2 Variable Constant 𝑅𝑂𝑃 = 𝑑ҧ 𝑥 𝐿𝑇 + 𝑧𝜎𝑑 𝐿𝑇
3 Constant Variable 𝑅𝑂𝑃 = 𝑑 𝑥 𝐿𝑇 + 𝑧𝑑𝜎𝐿𝑇
4 Variable Variable
𝑅𝑂𝑃 = 𝑑ҧ 𝑥 𝐿𝑇 + 𝑧 𝐿𝑇𝜎𝑑2 + 𝑑ҧ 2 𝜎𝐿𝑇
2
Service Level z value
90% 1.28 Note: Review the calculation of average
95% 1.65 and standard deviation
99% 2.33
Example. Case Number 1
Tingly takes Two-a-Day vitamins, which are delivered to his home by a
routeman seven days after an order is called in. At what point should
Tingly reorder?

d = 2 per day
LT = 7 days

ROP = d x LT
=2x7
= 14 vitamins
Example. Case 2
A restaurant uses an average of 50 jars of a special sauce each week. Weekly
usage of sauce has a standard deviation of 3 jars. The manager is willing to
accept no more than a 10 percent risk of stockout during lead time, which is
two weeks. Assume the distribution of usage is normal. Find ROP
ഥ 50 jars per week
𝒅= Acceptable Risk = 10%; Service Level = 90%
LT = 2 weeks Therefore Z = 1.28
𝝈𝒅 = 3 jars
𝑅𝑂𝑃 = 𝑑ҧ 𝑥 𝐿𝑇 + 𝑧𝜎𝑑 𝐿𝑇
𝑅𝑂𝑃 = 50𝑥2 + 1.28𝑥3 2
𝑅𝑂𝑃 = 100 + 5.43
𝑅𝑂𝑃 = 105.43 ≈ 106 𝑗𝑎𝑟𝑠
Example. Case 3
The motel in the preceding example uses approximately 600 bars of soap
each day, and this tends to be fairly constant. Lead time for soap delivery is
normally distributed with a mean of six days and a standard deviation of two
days. A service level of 90 percent is desired.
d = 600 bars per day Acceptable Risk = 10%; Service Level = 90%
𝑳𝑻= 6 days Therefore Z = 1.28
𝝈𝑳𝑻 = 2 days
𝑅𝑂𝑃 = 𝑑 𝑥 𝐿𝑇 + 𝑧𝑑𝜎𝐿𝑇
𝑅𝑂𝑃 = 600𝑥6 + 1.28𝑥600𝑥2
𝑅𝑂𝑃 = 3600 + 1536
𝑅𝑂𝑃 = 5136 bars
Example. Case 4
The motel replaces broken glasses at a rate of 25 per day. In the past, this quantity
has tended to vary normally and have a standard deviation of three glasses per day.
Glasses are ordered from a Cleveland supplier. Lead time is normally distributed
with an average of 10 days and a standard deviation of 2 days. What ROP should be
used to achieve a service level of 95 percent?
d = 25 glass per day Service Level = 95%
𝝈𝒅 = 3 glass per day Therefore Z = 1.65
𝑳𝑻= 10 days 𝝈𝑳𝑻 = 2 days
𝑅𝑂𝑃 = 𝑑ҧ 𝑥 𝐿𝑇 + 𝑧 𝐿𝑇𝜎𝑑2 + 𝑑ҧ 2 𝜎𝐿𝑇
2

𝑅𝑂𝑃 = 25𝑥10 + 1.65 10𝑥32 + 252 𝑥22

𝑅𝑂𝑃 = 250 + 83.97
𝑅𝑂𝑃 = 333.97 ≈ 334 𝑔𝑙𝑎𝑠𝑠
THANKYOU