IE 323 Study Set 2 Fall 2020

IE323 Production and Service Operations Planning I

Middle East Technical University, Fall 2020
Study Set 2

1. A certain company makes a complete line of valves. These valves are supplied directly to
customers from the factory warehouse. The valves are made in lots and the same production
facilities are used to make the valves. One particular valve has the following properties: The
demand rate () can be assumed to be known with certainty and constant at 2500 units per year.
The setup cost for each production run is 50 TL and the unit variable cost of production is 3 TL.
The inventory holding cost rate, i, is 0.20 per year. The production rate (P) is 10,000 units per
year. A period of 2 months is required from the time that a production requisition is received at
the factory until finished units begin to come off the production line. It is desired to determine
the optimal lot size and the warehouse reorder point based on the assumption that stock-outs
are not permitted.

a) Find the optimal production lot size.

b) What would be the optimal production lot size if the production rate were much larger
(almost infinite) than the demand rate?
c) What is the time between two production runs?
d) What is the maximum level of on hand inventory in the warehouse?
e) In how many days does the on-hand inventory at the warehouse reach the maximum level
after the first unit comes off the production line? (Assume 365 working days in a year for the
production line)
f) What is the reorder point of the warehouse based on the on-hand inventory?
g) For how long during a year is the production line making this particular valve?

2. A trader purchases wheat, corn and barley from local producers and sells them to some food
manufacturers. He stores all the commodities in the same warehouse which has a limited capacity
of 500 square feet of space. A pound of wheat, corn and barley consumes 0.5 ft 2, 0.4 ft2 and 1 ft2
area, respectively. Purchasing costs for the commodities are 0.29, 0.45 and 0.25 liras per pound,
respectively. Ordering cost is 5 liras for each commodity. The trader can sell 1000 pounds of
wheat, 1500 pounds of corn and 750 pounds of barley per year. Find the optimal order quantities
for the commodities. (Annual interest rate is 25%)

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IE 323 Study Set 2 Fall 2020

3. The Rataş Company is using mainly teak lumber in the manufacture of outdoor furniture. They
purchase teak lumber from a far away lumberjack in medium-to-large amounts and store it in
their lumber yard near the factory. Each order placed to the lumberjack costs K to them. They use
up lumber in the manufacture of outdoor furniture at the rate of  tons/month. Rataş assumes
that the inventory carrying costs for lumber are made up of two parts: inventory charge
(ic/ton/month) proportional to the average inventory, and warehousing cost (w/ton/month)
proportional to the maximum inventory. Rataş may allow for stock-outs of lumber, though
manufacturing of furniture may stop for a while, until the replenishment order arrives. They
assume a shortage cost of p/ton/month, when they are out of stock. Rataş assumes 20 days in a
month.
a) Formulate the total monthly cost function G(Q,B) for Rataş. (Let Q and B be the order quantity
and maximum stock-out level for lumber, respectively).
b) Derive the optimum order quantity, Q* and the backorder level, B*. Calculate the values of Q*
and B* if K=500 TL/order, c=120,000 TL/ton, w=5 TL/ton/month, p=500 TL/ton/month,
i=1%/month, =5 tons/month.
c) What should the minimum capacity of lumber yard (in tons) if Rataş continues to order in the
optimum order quantity?
d) What should the reorder point of Rataş be, if the lumberjack usually sends the order to Rataş
in 5 days?
e) What is Rataş’s longest delay (in days) in manufacturing, when Rataş is out of lumber stock?

4. There is a newsstand called Mac’s. A few regular customers have asked Mac to stock a particular
magazine. Mac has agreed even though sales have been slow. Based on past data, Mac has found
that a Poisson distribution with mean 5 closely fits the weekly sales pattern for the magazine.
Mac purchases the magazines for $0.50 and sells them for $1.50. He returns unsold copies to his
supplier, who pays Mac $0.10 for each. Find the number of these magazines he should purchase
from his supplier each week.

5. A small retailer of snorkeling equipment must decide how many snorkeling masks to order for
this summer season. The selling price for these masks is $20, while the cost to the retailer is only
$12. The retailer is very concerned about loss of goodwill, so she does not allow any unsatisfied
demand. In order to achieve this, she buys additional masks from her competitors at their retail
price of $25, when she is in stock-out. Masks left over at the end of the short selling season are

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IE 323 Study Set 2 Fall 2020

sold at a special discount price of $10 per mask. The manager of the store assumes that demand
is approximately normally distributed with a mean of 600 masks and a standard deviation of 200
masks.
a) How many masks should she order?
b) What is the expected number of masks that are left over for the discounted sales?
c) What is the expected number of masks she buys from the competitors?
d) What is the effect on the order quantity if she could reduce the standard deviation to 50?

6. HAM Rubber sells 144 tires per year to ZENIT airlines. Current price is 1000 TL/tire and ZENIT
assumes 10% is their annual interest on inventory carrying. The transfer of tires to ZENIT’s shop
costs ZENIT 5000 TL/order independent of the order size.
a) HAM rubber makes a reasonable profit if ZENIT orders at least 200 tires in each shipment.
How many units is ZENIT’s order size different from HAM’s ideal of 200 / order?
b) Ms Xaham the owner, plans to apply a 25 TL discount per tire for all the tires sold if the
order size is at least 200. Will ZENIT accept this bargain?
c) Mr Xaham, the owner’s long-time husband, says “ Wait a minute, boss. Why give all-units?
Make 25 TL an incremental discount with a lower price break than 200 to encourage ZENIT
order 200 or more.”. Can his idea work?

7. You are responsible for paper supplies in the copying room in a medium sized office. Paper usage
averages 8 boxes per week. Each box costs 25 TL. The shipping cost per order, regardless of the
size, is 50 TL, and receiving an order takes about an hour of your time, which costs the company
80 TL. Each order takes a week to arrive. The company figures financing costs at 15% per year.
Keeping the boxes organized costs 1.10 TL/week per box. Currently, you order two weeks’ worth
of supply with each order.
a) What is the average annual cost of this policy?
b) What is the optimal order quantity and associated annual total cost? Compare the optimal
policy with the current policy.
Assume that backorders are allowed. This can mean that copying work waits when paper runs
out. You figure the backorder cost to be 15 TL per box per week.
c) How do your optimal order quantity and annual total cost change?
d) What is the optimal backorder level permitted? What will be the average backorders? What
is the average waiting time of any backordered box?
e) What is the optimal reorder level with backordering?

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IE 323 Study Set 2 Fall 2020

8. A department store uses a (Q, s) policy to control its inventories. Sales of a pocket FM radio
average 1.4 radios per week. The radio costs the store $ 50.00, and fixed costs of replenishment
amount to $ 20.00. Holding costs are based on a 20 percent annual interest charge, and the store
manager estimates a $ 12.50 cost of lost profit and loss of goodwill if the radio is demanded when
out of stock. Reorder lead time is 2 weeks, and statistical studies have shown that demand over
the lead time is accurately described by a Poisson distribution. Find the optimal lot sizes and
reorder points for this item. Compute the type 1 and type 2 service levels.

9. Annual demand for the pencils at the campus store is normally distributed with mean 1,000 and
standard deviation 250. The store purchases the pencils for 6 cents each and sells them for 20
cents each. There is a two-month lead time from the initiation to the receipt of an order. The store
accountant estimates that the cost in employee time for performing the necessary paperwork to
initiate and receive an order is $20, and recommends a 22 percent annual interest rate for
determining holding cost. The cost of a stock-out is the cost of lost profit plus an additional 20
cents per pencil, which represents the cost of loss of goodwill.

a) Find the optimal value of the reorder point R assuming that the lot size used is the EOQ.
b) Find the simultaneous optimal values of Q and R.
c) Compare the average annual holding, setup, and stock-out costs of the policies determined
in parts (a) and (b).
d) What is the safety stock for this item at the optimal solution?
e) Re-solve the problem, substituting a Type 1 service level criterion of 95 percent for the
stock-out cost.
f) Re-solve the problem, substituting a Type 2 service level criterion of 95 percent for the
stock-out cost. Assume that Q is given by the EOQ.
g) Find the simultaneous optimal values of Q and R assuming a Type 2 ser vice level of 95
percent.

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IE 323 Study Set 2 Fall 2020

10. Cassorla’s Clothes sells a large number of white dress shirts. The shirts, which bear the store
label, are shipped from a manufacturer in New York City. Hy Cassorla, the proprietor, says, “I
want to be sure that I never run out of dress shirts. I always try to keep at least a two months’
supply in stock. When my inventory drops below that level, I order another two-month supply.
I’ve been using that method for 20 years, and it works.”
The shirts cost $6 each and sell for $15 each. The cost of processing an order and receiving new
goods amounts to $80, and it takes three weeks to receive a shipment. Monthly demand is
approximately normally distributed with mean 120 and standard deviation 32. Assume a 20
percent annual interest rate for computing the holding cost.
a) What value of Q and R is Hy Cassorla using to control the inventory of white dress shirts?
b) What fill rate (Type 2 service level) is being achieved with the current policy?
c) Based on a 99 percent fill rate criterion, determine the optimal values of Q and R that he
should be using. (Assume four weeks in a month for your calculations.)
d) Determine the difference in the average annual holding and setup costs between the policies
in parts (b) and (c).
e) Estimate how much time would be required to pay for a $25,000 inventory control system,
assuming that the dress shirts represent 5 percent of Hy’s annual business and that similar
savings could be realized on the other items as well.

11. Semicon is a start-up company that produces semiconductors for a variety of applications. The
process of burning in the circuits requires large amounts of nitric acid, which has a shelf life of
only three months. Semicon estimates that it will need between 1,000 and 3,000 gallons of acid
for the next three-month period and assumes that all values in this interval are equally likely. The
acid costs them $150 per gallon. The company assumes a 30 percent annual interest rate for the
money it has invested in inventory, and the acid costs the company $35 a gallon to store. (Assume
that all inventory costs are attached to the end of the three-month period.) Acid that is left over
at the end of the three-month period costs $75 per gallon to dispose of. If the company runs out
of acid during the three-month period, it can purchase emergency supplies quickly at a price of
$600 per gallon.
a) How many gallons of nitric acid should Semicon purchase? Experience with the marketplace
later shows that the demand is closer to a normal distribution, with mean 1,800 and standard
deviation 480.
b) Suppose that now Semicon switches to a 94 percent fill rate criterion. How many gallons
should now be purchased at the start of each three-month period?