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INVENTORY

Raw material Work in process Finished item

INVENTORY CONTROL

By: Aditya pal

Production & Industrial Engineering
IIT DELHI

Model number 1
Deterministic Model (EOQ)
INVENTORY COST

Assumption of this model

Holding cost Ordering cost Shortage cost 1. Demand D is known with certainty.
Or Or Or

2. Usage rate is constant.

Carrying cost Setup cost Stock out cost
Or
Procurement
cost 3. Shortage not allowed.
4. Lead time constant and known with certainty.
5. Order cost is fixed O.

EOQ Model
7. Holding cost/item/unit time Ch is know Annual Cost

8. No quantity discount is offered.

Holding Cost

Order Quantity

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EOQ Model EOQ Model

Annual Cost Annual Cost

Total stocking cost

Holding Cost Holding Cost

Order (Setup) Cost Order (Setup) Cost

Order Quantity Order Quantity

Finding the optimal quantity to order…

EOQ Model
Let’s say we decide to order in batches of Q…

Annual Cost Inventory position Number of D

Total stocking cost periods will be Q

Q
Total
Holding Cost
stocking The average
cost Order (Setup) Cost inventory for
(TSCmin) each period is…
Time
Period over which demand for Q has occurred
Q
Optimal Order Quantity
2
Order Quantity (Q*) Total Time

D Q*
O Ch
D Q*
TSC  O
Q* 2
Ch
Q* 2 Economic Order
Quantity – EOQ (Q*) Q* 
2OD
Ch

D Q* TSC*  2ODCh
TMC  O Ch  PD
Q* 2 Optimum length of 2O
time between orders : t* 
Ch

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If demand is known exactly, place an order when

inventory equals demand during lead time. Total Cost = Purchasing Cost + Ordering Cost + Inventory Cost

Order Q: When shall we order?

Quantity A: When inventory = ROP
Q Q: How much shall we order?
A: Q = EOQ
Inventory

Purchasing Cost = (total units) x (cost per unit)

Ordering Cost = (number of orders) x (cost per order)

Reorder
Point
(ROP) Inventory Cost = (average inventory) x (holding cost)
ROP = LTxD

Lead Time
Time
D: demand per period
Place Receive
LT: Lead time in periods
order order

Finding the optimal quantity to order… Example 1

Let’s say we decide to order in batches of Q… A particular item has a demand of 9,000
unit/year. The cost of one procurement is Rs100
Inventory position Number of D
and the holding cost per unit is Rs. 2.4 per year.
periods will be Q The replacement is instantaneous and no
Q shortages are allowed. Determine
i. The economic lot size
The average
inventory for ii. The number of orders per year
each period is…
Time iii. The time between orders,
Period over which demand for Q has occurred
Q
iv. The total cost per year if the cost of one unit is
2
Total Time Rs1

Solution Example 2
• A wholesaler supplies 30 stuffed dolls each
D  9000units / year; O  Rs100 / procurement ; Ch  Rs 2.40 / unit / year weekday to various shops. Dolls are purchased
(i ) EOQ 
2OD

2  100  9000
 866units / procurement from the manufacturer in lots of 120 each of
Ch 2.40
Rs1,200 per lot. Every order incurs a handling
D 9000
(ii )no  
EOQ 866
 10.4order / year. charge of Rs60 plus a freight charge of Rs 250
1
per lot. Multiple and fractional lots also can be
(iii) to   0.0962 year  1.15monthsbetween procurement ordered, and all order are filled the next day.
10.4
(iv )Co 9000  1  2ODCh The incremental cost is Rs 0.6per year to store
2 100  9000  2.4 a doll in inventory.
 9000 

 Rs11,080 / year

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Continue… Solution
D  30  250  7,500units ( Annual Demand )
1,200
The wholesaler finances inventory investment Unit cos t of purchase" P" 
120
 Rs10
by paying its holding company 2% monthly Ordering cos t" O"  Rs (60  250)  Rs310 / order
for borrowed funds. Find EOQ and frequency 2 12
inventory carrying cos t Ch  Rs (0.6  10  ( ))  Rs3 / unit / year
of orders assuming 250 weekdays in a year. 100
2OD 2  310  7500
EOQ    1,245units
Ch 3
D 7,500
no    6orders / year
EOQ 1,245
1 1
to   year  2months
no 6
order of 1,245units should be placed every two months

Model 2 Question
EOQ Model with Quantity
Discount
Quantity (per order) Price (per item)

0 ≤ Q < 99 40
• Supplier commonly offer a quantity discount
100≤ Q<249 39.6
for sufficiently large number of units
purchased at once. The basic objective behind 250≤ Q<499 39
the model is to MINIMIZE TOTAL 500+ 38
MATERIAL COST per year.
Demand is known as 10 item/week ordering cost Rs 100/order.
Holding cost expressed as % is equal to 18% per year. Above is
quantity discount table. Determine the optimal order size.

Ch = i x p Ch = i x p

Calculate EOQ taking P=38 Calculate EOQ taking P=39

EOQ= √ 2x 100 x 520

0.18 x38 = 123 EOQ= √ 2x 100 x 520
0.18 x39 = 121

Not falling in the range of order for 38 Not falling in the range of order for 39

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Calculate TMC

Ch = i x p
TMC =
D O
+
Qₓ
ch + PD
Qₓ 2
Calculate EOQ taking P=39.6

√
TMC at Q=500 for P=38 => 21574
2x 100 x 520
EOQ= 0.18 x39.6 = 121 TMC at Q=250 for P=39 => 21366

TMC at Q=121 for P=39.6 => 21453

Falling in the range of order for 39
TMC at Q=100 for P=39.6 => 21468

Question
Quantity (per order) Price (per item)
Ch = i x p
Q < 500 10
Calculate EOQ taking P=9
Q ≥ 500 9

√
Demand is known as 2500item/yr ordering cost Rs 100/order. 2x 100 x 2500
Holding cost expressed as % is equal to 25% per year. Above is
EOQ= 0.25 x9 = 471
quantity discount table. Determine the optimal order size.

Not falling in the range of order for 9

Calculate TMC

Ch = i x p
TMC =
D O
+
Qₓ
ch + PD
Qₓ 2
Calculate EOQ taking P=10

√
TMC at Q=447 for P=10 => 26118
2x 100 x 2500
EOQ= 0.25 x10 = 447 TMC at Q=500 for P=9 => 23562

Falling in the range of order for 9

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MODEL NO. 3
EPQ
• A problem frequently encountered by the Q

manufactures is to determine how many units M

of products to produce during a production

run. This quantity is known as EPQ. Imax

-D
M-D

t1

t1 is the time period during which the stock

is growing up at a rate (M-D) items per
EPQ 
2OD
unit time D
(Optimum lot size) Ch (1  )
M
Imax = (M-D)t1

Imax = Q-Dt1
TSCmin D
Imax = (1-D/M)Q  2ODCh (1  )
M

Example 2 Solution
D  12,000 units / year
M  2,000  12  24,000 units / year
O  Rs 400 / setup
• A company has a demand of 12,000 units/year Ch  Rs 0.15  12  Rs1.80 / unit / year
for an item it can produce 2,000 such items per 2OD M 2  400  12,000 24,000
(i ) EPQ   
month. The cost of one setup is Rs 400 and the Ch M D 1. 8 24,000  12,000
holding cost /unit/month is Rs 0.15.  3,264units / setup
M D
i. Find the optimum lot size and the total cost (ii )Co  12,000  4  2ODCh 
M
per year, assuming the cost of 1 unit as Rs 4. 12,000
 48,000  2  400 12,000  1.8 
ii. Also find the maximum inventory, 24,000

manufacturing time and total time.  Rs50,940 / year

M D 12,000
(iii )Im   EPQ   3,264  1,632units
M 24,000

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Example 3
• An item is produced at the rate of 50 items per
Im day. The demand occurs at the rate of 25 items
(iv) Manufacturing time "t 1" 
(M  D) per day. If the setup cost is Rs100 per setup
(v )Total time to 
EPQ 3,264
  0.272 years and holding cost is Rs0.01 per unit of item per
D 12,000 day
i. find the economic lot size for one run,
assuming that shortages are not permitted.
ii. Also find the time of cycle and
iii. minimum total cost for one run

Solution MODEL NO. 4

M  50 items / day; D  25items / day
O  Rs100 / setup; Ch  Rs 0.01 / unit / day SHORTAGE MODEL
2OD M 2 100  25 50 • This inventory model taking care of shortage.
(i ) EPQ  
Ch M D 0.01 25 • In actual practice shortage may take place and
 1,000 items hence shortage cost also need to be considers.
EPQ 1,000
(ii )to    40days • Shortages may also be allowed for certain
D 25
advantages:
M D
Minimum daily cos t  2ODCh  1) Shortage increases the cycle time and hence
M
spread the ordering cost over a longer period of
25 time
 2 100  25  0.01 
50 2) Shortage result in decreased net stock inventory
 Rs5
resulting in decreased inventory carrying cost.
(iii ) Minimum total cos t / run  Rs5  40  Rs 200

√ √ √ √
Q* 2OD Ch+Cs Q* 2OD Ch+Cs
= =
Ch Cs Ch Cs
Total optimal order size

Q Imax =
√ √ 2OD
Ch
Cs
Ch + Cs
Imax

√ √
D

Min cost/time = 2OD Ch Cs

s Ch + Cs
Total optimal inventory cost
t0

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Solution
Example 4
2OD Ch  Cs
• Find the results of “example 2” if in addition (i ) Q* 
Ch Cs
to the data given in that problem the cost of 2 100  9000 (2.40  5)
 
shortage is also given as Rs5 per units per 2.40 5
year.  1,053units / procurement
Cs
(ii )C min  9000  1  2ODCh
D  9,000units / year; O  Rs100 / procurement
Ch  C s
5
Ch  Rs 2.40 / unit / year; Cs  Rs 5 / unit / year
C min  9000  2  100  9000  2.4
2.40  5
 Rs10,710 / year
9000
(iii) no   8.55
1,053
1
(iv )Time between orders" to"   0.117 year  1.4months
8.55

PROBABILISTIC MODEL
• In most of the situation demand is not known • Over stocking cost C1 = C+ Ch – V
with certainty and is only probabilistic. C=cost price/item
Ch= unit carrying cost
• In such situations such policies are choose
that minimizes the expected cost rather than V= salvage value
the actual cost. • Under stocking cost C2 = S-C- Ch /2+Cs
C=cost price/item
Cs= shortage cost
S= selling price/item

The optimum value of Z

∫F(x)dx = C1+C2
C2 C2
∑p(d)< C +C < ∑p(d)
Z Z-1
Z

0
d=0 1 2 d=0

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• A news paper boy buys papers for 5 paise • In each day’s demand is independent of the
each and sell them for 6 paise each. He cannot previous day’s, how many paper should be
return unsold newspapers. Daily demand D for ordered each day.
newspaper follows the distribution:
D 10 11 12 13 14 15 16

P 0.05 0.15 0.40 0.20 0.1 0.05 0.05

solution selective control system

• C1= Rs 0.05 • Inventory management is based on selective
• C2 = Rs (S-C) = 0.06-0.05=0.01 control depending on item to be stored, upon
the value or the importance. The selective
D 10 11 12 13 14 15 16
inventory management plays a very important
role in the minimize the inventory cost.
P 0.05 0.15 0.40 0.20 0.10 0.05 0.05
∑P 0.05 0.20 0.60 0.80 0.90 0.95 1

ABC Analysis
C 100
u
m 90
u
What is ABC analysis? la
t 75
• Always Better Control iv
e
A: 5 to 10 % of the total number of items accounting %
for 70 to 80% of the annual usage value, v
al
B: 10 to 20 % accounting for about 15 to 20% of the u
annual usage value, and e

C: 70 to 80 % of the total number of items accounting

for 5 to 15% of the annual usage value,
A B C
0 100
10 30
Cumulative % number

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VED Analysis SDE Analysis

• Vital Essential Desirable • This is based on relative case of availability.
• In this system items are classified on the bases of
there importance . 1) S- Scarce item
1) Absence of vital item will stop the system. 2) D- Difficult item
2) Absence of essential item will reduce the 3) E- Easily available
efficiency of system &
3) Absence of desirable item has no immediate
effect on the system

GATE-2007
FNSD Analysis
MODEL 3
• This analysis divided items into four categories In a machine shop, pins of 15 mm diameter are
in the descending order of their consumption produced at a rate of 1000 per month and the
same is consumed at a rate of 500 per month.
rate. The production and consumption continue
1) F- fast simultaneously till the maximum inventory is
2) N- Normal reached. Then inventory is allowed to reduce to
zero due to consumption. The lot size of
3) S- slow production is 1000. If backlog is not allowed, the
4) D- Dead maximum inventory level is:
(a) 400 (b) 500 (c) 600 (d) 700
ANS-B

GATE-2004
SOLUTION
MODEL 4
A company has an annual demand of 1000
units, ordering cost of Rs. 100/ order and
carrying cost of Rs. 100/unit-year. If the
stock-out costs are estimated to be nearly Rs.
400 each time the company runs out-of-
stock, then safety stock justified by the
carrying cost will be:
(a) 4 (b) 20 (c) 40 (d) 100

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Probabilistic Model

ABC Analysis IES-2007

In the EOQ model, if the unit ordering cost is
doubled, the EOQ
(a) Is halved
(b) Is doubled
(c) Increases 1.414 times
(d) Decreases 1.414 times

Ans. (c)

IES-2002
• Economic Order Quantity is the quantity at
which the cost of carrying is:
(a) Minimum
(b) Equal to the cost of ordering
(c) Less than the cost or ordering
(d) Cost of over-stocking
IES-2008
• In the basic EOQ model, if demand is 60 per
month, ordering cost is Rs. 12 per order,
holding cost is Rs. 10 per unit per month,
what is the EOQ?
(a) 12 (b) 144 (c) 24 (d) 28

Ans. (a)
Ans. (b)

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IES-2006 IES-2009
• If the annual demand of an item becomes half, • If demand is doubled and ordering cost, unit
ordering cost double, holding cost one-fourth
and the unit cost twice, then what is the ratio of cost and inventory carrying cost are halved,
the new EOQ and the earlier EOQ? then what will be the EOQ?
(a) 1/2 (a) Half (b) Same (c) Twice (d) Four times
(b) 1/
2

(c) √2
(d) 2

Ans. (d) Ans. (c)

IES-1994 IES-1995
• There are two products A and B with the • In inventory control theory, the economic
following characteristics product demand (in order quantity (E.O.Q.) is:
units), order cost (in Rs./order), holding cost (in
Rs./unit/years) (a) Average level of inventory
• A. 100 100 4 (b) Optimum lot size.
• B. 400 100 1 (c) Lot size corresponding to break-even analysis
The economic order quantities (EOQ) of product (d) Capacity of a warehouse.
A and B will be in the ratio of:
(a) 1: 1 (b) 1: 2 (c) 1: 4 (d) 1 : 8

Ans. (c) Ans. (b)

IES-2002
• ordering costs of Rs. 'P' per order and
carrying costs Rs. '1' per unit per year. The
economic order quantity for a purchasing
model having no shortage may be
determined from
(a) 24P/AI (b) 24AP/I (c) 2AP/I (d) 2AI/P

Ans. (c)

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