Unlock document.
This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
Chapter 13 - Inventory Management
CHAPTER 13
INVENTORY MANAGEMENT
Teaching Notes
This is a fairly long and important chapter. Important points are:
1. Good inventory management is important for successful organizations.
2. The key inventory management issues are when to order and how much to order.
3. Because all items are not of equal importance, it is necessary to establish a classification system
for allocating resources for inventory control.
4. EOQ models answer the question of how much to order. Variations of the basic EOQ model
include the quantity discount model and the economic production quantity (EPQ) model.
5. EOQ models tend to be rather robust: even though one or more of the parameters may be only
roughly correct, the model can yield a total cost that is close to the actual minimum.
6. ROP models are used to answer the question of when to order. Different models are used,
depending on whether demand, lead time, or both are variable.
7. Other models described are the fixed interval model and the single-period model.
8. All of the models in this chapter pertain to independent demand.
The single-period model is used to handle ordering of perishables (e.g., fresh fruits and vegetables,
seafood, and cut flowers) as well as items that have a limited useful life (e.g., newspapers and magazines).
Analysis of single-period situations generally focuses on two costs: shortage and excess. Shortage costs
may include a charge for loss of customer goodwill as well as the opportunity cost of lost sales or
unrealized profit per unit. Excess cost pertains to items left over at the end of the period and is the
difference between purchase cost and salvage value. There may be costs associated with disposing of
excess items, which would make the salvage value negative and hence increase the excess cost per unit.
Answers to Discussion and Review Questions
1. Inventories are held: (1) to meet anticipated customer demand, (2) to smooth production
2. Effective inventory management requires: (1) a system to keep track of inventory on hand and on
3. The four costs associated with inventories include the following:
(1) Purchase cost – Amount paid to a vendor or supplier to buy the inventory.
(2) Carrying or holding costs – Cost of physically having items in storage. Costs include interest,
insurance, taxes, depreciation, picking, and warehousing costs (heat, light, rent, and security).
13-3
Education.
11. Service level can be defined in a number of ways. The text focuses mainly on “the probability
that demand will not exceed supply during lead time, i.e., that the amount of stock on hand will
12. The A-B-C approach refers to the classification of inventory items according to some measure of
importance, usually annual dollar value, and allocating control efforts on that basis. Although
13. In effect, this situation is a “quantity discount” case with a time dimension. Hence, buying larger
quantities will result in lower annual purchase costs, lower ordering costs (due to fewer orders),
14. A decrease in setup time will cause a decrease in the numerator of the formula for the economic
run quantity (Economic Production Quantity). This will lead to a decrease in the economic run
15. The single-period model is used to handle ordering of perishables (e.g., fresh fruits, vegetables,
seafood, & cut flowers) and items that have a limited useful life (e.g., newspapers, magazines, &
16. The optimal stocking level can be less than the expected demand when excess costs are high and
shortage costs are low.
17. A company can reduce the need for inventories by:
a. using standardized parts for multiple products
b. improving demand forecasting
Taking Stock
1. a. If we buy additional amounts of a particular good to take advantage of quantity discounts,
then we will save money on purchasing cost per unit and annual purchasing costs of the item.
Chapter 13 - Inventory Management
b. If we treat holding cost as a percentage of the unit price, then as the unit price increases, so
will the holding cost. As a result, if we are using the EOQ approach, we will place smaller
process inventory, more efficient operations, improved customer service, and greater
assurance of material availability.
2. When making inventory decisions involving holding costs, setting inventory levels, and deciding
on quantity discount purchases, the materials manager, the plant manager, the production
3. Technology has had a tremendous impact on inventory management. The utilization of bar coding
and RFID tags has reduced the cost of taking physical inventory and has enabled real time
Critical Thinking Exercises
1. The expansion of menu offerings provides fast food companies with a competitive edge in terms
of improving customer satisfaction and service. However, it has also complicated inventory
management at a company. There are more ingredients and inventory items to order and to
2. A supermarket manager could evaluate criticalness of an inventory shortage by answering the
following questions:
a. How important is the item? For example, does it relate to a holiday or other important events,
e.g., a graduation?
b. Are comparable substitutes readily available within the manager’s supermarket?
c. What alternatives are available at other supermarkets?
d. Is this an occasional occurrence, or indicative of a larger, perhaps ongoing, problem?
3. The relevant considerations related to the purchase of stamps include:
a. How many stamps does he have now? Does he know how many he has? If so, how many?
b. What is his usage rate or current need for stamps?
c. What else does he need the cash for today?
13-5
Education.
4. Student answers will vary. Some possible answers are provided below:
a. Intentionally over-estimating or under-estimating any inventory costs would violate the
Virtue Principle.
b. If a buyer purchased two years’ worth of an item to decrease purchasing costs, this action
would violate the Utilitarian Principle due to the increase in carrying costs.
Chapter 13 - Inventory Management
13-6
Education.
Solutions
1. a. Given:
Determine an A-B-C classification for the following items:
Item
Unit
Cost
Annual
Volume
(00)
1
$100
25
2
$80
30
3
$15
60
4
$50
10
5
$11
70
6
$60
85
Step 1:
Determine the Annual Dollar Value (Unit Cost * Annual Volume) for each item and the sum of
the individual Annual Dollar Values.
Item
Unit
Cost
Annual
Volume
(00)
Annual
Dollar
Value
1
$100
25
$2,500
2
80
30
2,400
3
15
60
900
4
50
10
500
5
11
70
770
6
60
85
5,100
12,170
Chapter 13 - Inventory Management
13-7
Education.
Step 2:
Arrange the items in descending order based on Annual Dollar Values. Determine the A, B, and
C items. Then, determine the percentage of items and the percentage of Annual Dollar Value for
each category (round to two decimals).
Item
Annual
Dollar
Value
Category
Percentage of
Items
Percentage of Annual
Dollar Value
6
$5,100
A
16.67%
[(1/6)*100]
41.91%
[($5,100/$12,170)*100]
1
2,500
B
33.33%
[(2/6)*100]
40.26%
[($4,900/$12,170)*100]
2
2,400
3
900
C
50.00%
[(3/6)*100]
17.83%
[($2,170/$12,170)*100]
5
770
4
500
12,170
100.00%
100.00%
b. Given:
D = 4,500, S = $36, and H = $10.
10
0 H
c. Given:
D = 18,000/year, S = $100, H = $40 per unit per year, p = 120 units per day, and u = 90
units/day.
Find the economic production quantity (EPQ) (round to an integer value):
Chapter 13 - Inventory Management
13-8
Education.
2. a. Given:
The following table contains figures on the monthly volume and unit costs for a random
sample of 16 items. Develop an A-B-C classification for these items:
Item
Unit Cost
Usage
K34
$10
200
K35
25
600
K36
36
150
M10
16
25
M20
20
80
Z45
80
200
F14
20
300
F95
30
800
F99
20
60
D45
10
550
D48
12
90
D52
15
110
D57
40
120
N08
30
40
P05
16
500
P09
10
30
Chapter 13 - Inventory Management
Step 1:
Determine the Annual Dollar Value (Unit Cost * Usage) for each item and the sum of the
individual Annual Dollar Values.
Item
Unit Cost
Usage
Annual
Dollar
Value
K34
$10
200
$2,000
K35
25
600
15,000
K36
36
150
5,400
M10
16
25
400
M20
20
80
1,600
Z45
80
200
16,000
F14
20
300
6,000
F95
30
800
24,000
F99
20
60
1,200
D45
10
550
5,500
D48
12
90
1,080
D52
15
110
1,650
D57
40
120
4,800
N08
30
40
1,200
P05
16
500
8,000
P09
10
30
300
94,130
Chapter 13 - Inventory Management
Education.
Step 2:
Arrange the items in descending order based on Annual Dollar Values. Determine the A, B,
and C items. Then, determine the percentage of items and the percentage of Annual Dollar
Value for each category (round to two decimals).
Item
Annual
Dollar
Value
Category
Percentage of
Items
Percentage of Annual
Dollar Value
F95
$24,000
A
18.75%
[(3/16)*100]
54.83%
[($55,000/$94,130)*100]
Z45
16,000
K35
15,000
P05
8,000
B
31.25%
[(5/16)*100]
31.55%
[($29,700/$94,130)*100]
F14
6,000
D45
5,500
K36
5,400
D57
4,800
K34
2,000
C
50.00%
[(8/16)*100]
10.02%
[($9,430/$94,130)*100]
D52
1,650
M20
1,600
F99
1,200
N08
1,200
D48
1,080
M10
400
P09
300
94,130
100.00%
100.00%
b. Given:
Determine an A-B-C classification for the following items:
Item
Usage
Unit Cost
4021
90
$1,400
9402
300
12
4066
30
700
6500
150
20
9280
10
1,020
4050
80
140
6850
2,000
10
3010
400
20
4400
5,000
5
