30 Questions
What is the relationship between the Safety Stock and the Probability of a Stockout?
As Safety Stock increases, the Probability of a Stockout decreases
What is the Zvalue corresponding to a 97.5 percent service level?
1.96
What is the formula to calculate the statistical reorder point?
ROP = μ + ZσdLT
What is the average demand during lead time (μ) for the part at L Inc.?
550 units
What is the standard deviation of demand during lead time (σdLT) at L Inc.?
40 units
What is the service level desired by the supply chain manager at L Inc.?
95 percent
What is the required safety stock to achieve a 95 percent service level?
66 units
What is the statistical reorder point (ROP) for the part at L Inc.?
616 units
What is the purpose of calculating the safety stock?
To minimize the probability of stockout
What is the additional safety stock required to attain a 99 percent service level?
40 units
What is the primary purpose of calculating the statistical reorder point?
To determine the lowest inventory level at which a new order should be placed.
What assumption is made about the lead time in ROP Model 1?
That the lead time is constant.
What is the formula for calculating safety stock in ROP Model 1?
x  μ = ZσdLT
What does the probability (1  α) represent?
The probability that inventory is sufficient to cover demand.
What is the primary difference between ROP Model 1 and ROP Model 2?
The assumptions about demand and lead time.
What is the purpose of the reorder point?
To avoid stockouts by ensuring that a new order is placed at the right time.
What is the role of the service level in inventory management?
It determines the desired probability of having sufficient inventory to meet demand.
What is the relationship between the standard deviation of demand during lead time and safety stock?
The standard deviation affects the calculation of safety stock.
What is the formula for calculating the statistical reorder point (ROP)?
ROP = μ + ZσdLT
What are the two primary models for calculating the statistical reorder point?
Model 1: ROP with probabilistic demand and constant lead time, and Model 2: ROP with constant demand and probabilistic lead time.
A 97.5 percent service level corresponds to the _______________ of 1.96.
Zvalue
The required safety stock is 0 and the probability of _______________ would be 50%.
stockout
The statistical reorder point (x) can be calculated as the average demand during the order's delivery _______________ time plus the desired safety stock.
lead
The standard deviation of demand during _______________ time (σdLT) is 40 units.
lead
A 95 percent service level corresponds to a _______________ of 1.65 standard deviations above the Average.
Zvalue
The ROP for Q1 is _______________ + 66 units = 616 units.
550
The manager must reorder the part from their supplier when their current stock level reaches _______________ units.
616
The supply chain manager wants to determine the safety stock and statistical reorder point that result in _______________ percent stockouts.
5
The manager wants to know the additional safety stock required to attain a _______________ percent service level.
99
L Inc. stocks a crucial part that has a normally distributed demand during the _______________ period.
reorder
Study Notes
Inventory Management: Cost and Optimization
 Inventory Turnover Ratio: measures the number of times inventory is sold and replaced within a period
 Average Inventory at Cost: calculates the average cost of inventory held during a period
Inventory Costs

Ordering Costs:
 Refers to transaction costs associated with replenishing inventories
 Includes order preparation, transmission, and receiving costs

Holding (Carrying) Costs:
 Incurred for holding inventory in storage
 Includes opportunity costs, storage and warehouse management, taxes, insurance, obsolescence, spoilage, and shrinkage

Stockout Costs:
 Refers to the costs incurred when a company does not have inventory available to meet demand
 Includes lost sales, opportunity costs, and potential loss of future sales and profits
Total Annual Inventory Cost (TAIC)
 TAIC Formula: TAIC = Annual Purchase Cost + Annual Holding Cost + Annual Order Cost
 Annual Purchase Cost: calculates the total cost of purchasing inventory
 Annual Holding Cost: calculates the total cost of holding inventory
 Annual Order Cost: calculates the total cost of ordering inventory
Economic Order Quantity (EOQ)
 EOQ Formula: EOQ = √(2 * R * S) / (k * C)
 EOQ Cost TradeOffs: balances the tradeoff between annual holding costs and annual order costs
 EOQ Exercise: calculates the optimal order quantity for a company with a steady demand rate, instantaneous replenishment, and known lead time
Quantity Discount Model
 Quantity Discount Model: considers the tradeoff between larger quantities and price discounts vs. higher inventory holding costs
 Price Break Model: computes the total annual inventory cost for each price level to find the optimal order quantity
 TwoStep Procedure: computes the EOQ for each price level and finds the feasible EOQ or price break point
Reorder Point (ROP) and Probabilistic Demand
 ROP Formula: ROP = μ + ZσdLT
 ZValue: determines the safety stock and statistical reorder point for a desired service level
 Statistical Reorder Point (ROP): calculates the reorder point based on the average demand during lead time and desired safety stock
Concept of Inventory Management
 Inventory can be one of the most expensive assets of an organization
 Inventory management policy affects how efficiently a firm deploys its assets in producing goods and services
 The right amount of inventory supports manufacturing, logistics, and other functions
 Excessive inventory is a sign of poor inventory management that creates an unnecessary waste of scarce resources
 Primary functions of inventory are:
 To service the market (downstream players)
 To buffer from uncertainty in the marketplace
Types of Inventory
 Four broad categories of inventories:
 Raw materials: items that are bought from suppliers to use in the production of a product
 Workinprocess (WIP) inventory: partially processed materials not yet ready for sales
 Finished goods inventory: completed products ready for shipment
 Maintenance, repair & operating (MRO): materials & supplies used in producing products
Concepts of Inventory Management
 Inventory turnover or turnover ratio: measures how many times inventory “turns” in an accounting period
 Calculated by dividing the cost of revenue (cost of goods sold) by average inventory
 Managerial implication: purchase cost does not affect the order decision if there is no quantity discount
Economic Order Quantity (EOQ)
 The optimum Q (the EOQ) – method 2: making Annual Holding Cost (AHC) = Annual Order Cost (AOC)
 AHC = average inventory hold across the year * annual holding cost per unit = (Q/2)(kC)
 AOC = (R/Q)*S
 Q²KC = 2R*S
 Q = √(2RS/KC)
Economic Order Quantity Exercise
 LV Corporation: R = 7,200 units, S = $100 per order, k = 20%, C = $20 per unit, LT = 6 days
 Q = √(2RS/KC) = √(27,200100/0.20*20) = 600 units
 Annual purchase cost = RC = 7,200units$20 = $144,000
 Annual holding cost = Q/2kC = 600/20.20$20 = $1,200
 Annual order cost = R/QS = 7,200/600$100 = $1,200
Reorder Point (ROP)
 The Statistical Reorder Point (ROP): the lowest inventory level at which a new order must be placed to avoid a stockout
 ROP = Average demand during the order’s delivery lead time + Safety stock
 Two models:
 Model 1: ROP with probabilistic (unknown) demand and constant lead time
 Model 2: ROP with constant demand and probabilistic (unknown) lead time
Economic Order Quantity (EOQ) Model
 The EOQ model determines the optimal order size that minimizes total annual inventory costs, which is the sum of annual order costs and annual inventory holding costs.
 The model is based on a tradeoff between annual inventory holding costs and annual order costs.
 Assumptions of the EOQ model:
 Demand must be known and constant
 Lead time is known and constant
 Replenishment is instantaneous
 Price is constant
 Holding cost is known and constant
 Ordering cost is known and constant
 Stockouts are not allowed
Total Annual Inventory Cost (TAIC)
 TAIC = Annual Purchase Cost + Annual Holding Cost + Annual Order Cost
 Annual Purchase Cost (APC) = annual demand * purchase cost per unit
 Annual Holding Cost (AHC) = average inventory hold across the year * annual holding cost per unit
 Annual Order Cost (AOC) = (R/Q) * S
Economic Order Quantity (EOQ) Formula
 TAIC = (RC) + [(Q/2)(k*C)] + [(R/Q)*S]
 The optimum Q (EOQ) is calculated by taking the first derivative of TAIC with respect to Q and setting it equal to zero.
Reorder Point (ROP)
 The Statistical Reorder Point (ROP) is the lowest inventory level at which a new order must be placed to avoid a stockout.
 ROP = Average demand during the order's delivery lead time + Safety stock
 Instock probability is commonly referred to as the service level.
ROP Model 1  Probabilistic Demand and Constant Lead Time
 This model assumes that lead time is constant and demand during delivery lead time is unknown (but normally distributed).
 The average demand during the lead time is represented by μ, and the standard deviation formula is σdLT.
 Safety stock is (x − μ) = ZσdLT, and ROP is represented by x = μ + ZσdLT.
 The probability of stockout is represented by α, and the probability that inventory is sufficient to cover demand is (1 − α).
Explore inventory management concepts such as inventory turnover ratio, average inventory at cost, ordering costs, and holding costs. Learn how to optimize inventory management for business success.
Make Your Own Quizzes and Flashcards
Convert your notes into interactive study material.