Concordia University

INDU 6211
Production Systems and Inventory
Assignment # 4

ONLINE

Dr. Onur Kuzgunkaya Fall 2020

1) Lake Grove Confectionaries (LGC) sells chocolates for the holiday season in specially designed
boxes. The firm sells four designs, and currently all packaging is done in the plant as chocolates are
manufactured. All manufacturing and packaging for the holiday season are completed before the start
of the season. The demand forecast for each of the four designs is normally distributed, with a mean
of 20,000 and a standard deviation of 8,000. Each box costs $10 and is sold for $20. Any unsold boxes
at the end of the season are discounted to $8, and they all sell out at this price. The cost of holding a
box in inventory for the entire season before selling it at a discount is $1.

a. How many boxes of each design should LGC manufacture?

b. What is the expected profit from this policy?
c. How many boxes does LGC expect to sell at a discount?

d. An option being considered by LGC is to separate chocolate production from packaging. Chocolates
will be produced before the start of the season, but packaging will be done on an express line as orders
come in. The express line and separation of steps adds $2 to the cost of production. How many boxes
of chocolates should LGC manufacture if it decides to postpone packaging? What is the expected
profit? How many boxes will LGC sell at a discount if it uses postponement?

e. At what additional cost of postponement (instead of the current $2) would LGC be indifferent
between operating with and without postponement?
Inputs Box 1 Box 2 Box 3 Box 4
Expected demand, D 20,000 20,000 20,000 20,000
Standard deviation of demand, σ D 8,000 8,000 8,000 8,000
Unit costs, C $10 $10 $10 $10
Sales price, p $20 $20 $20 $20
Discount price $8 $8 $8 $8
Inventory holding costs for season $1 $1 $1 $1

Salvage value, s $7 $7 $7 $7
Cost of understocking, C u $10 $10 $10 $10
Cost of overstocking, C o $3 $3 $3 $3

Outputs
Optimal cycle service level 0.7692 0.7692 0.7692 0.7692 Total
z 0.7363 0.7363 0.7363 0.7363
Optimal production size 25,891 25,891 25,891 25,891 103562.11
Expected overstock 6,965 6,965 6,965 6,965 27,859.59
Expected understock 1074 1074 1074 1074
Expected profits $168,362 $168,362 $168,362 $168,362 $ 673,446.37

D
Inputs Box 1
Expected demand, D 20,000
Standard deviation of demand, σ D 8,000
Aggregate expected demand on postponement 80,000
Standard deviation of aggregate demand 16,000
Unit costs, C $12
Sales price, p $20
Discount price $8
Inventory holding costs for season $1

Salvage value, s $7
Cost of understocking, C u $8
Cost of overstocking, C o $5

Outputs
Optimal cycle service level 0.6154
z 0.2934
Optimal production size 84,694
Expected overstock 9,003
Expected understock 4309
Expected profits $560,515
e)
Inputs Box 1 Box 2 Box 3 Box 4
Expected demand, D 20,000 20,000 20,000 20,000
Standard deviation of demand, σ D 8,000 8,000 8,000 8,000
Aggregate expected demand on postponement 80,000
Standard deviation of aggregate demand 16,000
Unit costs, C $10.70
Sales price, p $20
Discount price $8
Inventory holding costs for season $1

Salvage value, s $7
Cost of understocking, C u $9
Cost of overstocking, C o $4

Outputs
Optimal cycle service level 0.7154
z 0.5692
Optimal production size 89,108
Expected overstock 11,944
Expected understock 2836
Expected profits $673,446
2) A publisher sells books to Borders at $12 each. The marginal production cost for the publisher
is $1 per book. Borders prices the book at $24 and expects demand to be normally distributed with a
mean of 20,000 and a standard deviation of 5,000. Borders places a single order with the publisher.
Currently, Borders discounts any unsold books down to $3 and any unsold books sell at this price.
a. How many books should Borders order? What is their expected profit? How many books do
they expect to sell at a discount?
b. What is the profit that the publisher makes given Borders' actions?
A plan under discussion is to refund Borders $5 per unsold book. As before Borders will discount them
to $3 and sell any that remain.
c. Under this plan how many books will Borders order? What is the expected profit for Borders?
d. How many books are expected to be unsold? What is the expected profit for the publisher? What
should the publisher do?

Option 1 Option 2=Buyback

Inputs 1 color 4 color

Anticipate demand 20,000 20,000
Standard deviation 5,000 5,000
Unit costs $12 $12
Sales price $24 $24
Disposal value $3 $8
Inventory holding costs
buyback 5

Salvage value $3 $8
Cost of understocking $12 $12
Cost of overstocking $9 $4

Outputs
Optimal cycle service level 0.5714 0.7500
z 0.1800 0.6745
Optimal production size 20,900 23,372
Expected overstock 2,477 4,118
Expected understock 1577 746
Expected profits $198,784 $214,578
Publisher Profits $229,900.68 $236,505.84
3)Talbot Publishing Company’s production planning manager has provided the following historical
sales data for its leading textbook on forecasting: The firm is considering using a basic exponential
smoothing model with α = 0.2 to forecast this item’s sales.

a. Use the sales average of 20,000 units through year 3 as the forecast for period 4. Prepare
forecasts for years 5 through 7 as of the end of year 4.

b. Calculate the average error and MAD value for the three forecasts using the actual sales data
provided. Estimate the standard deviation of the forecast errors using the calculated MAD.

c. Redo the forecast and MAD calculations, updating the forecasts for years 6 and 7 at the end of
years 5 and 6, respectively. What do you observe?

Year Sales
(in
1,000
units)
4 21
5 18
6 20
7 17

Demand Forecast Absolute Error

Period t Dt Level Lt Ft Error Et At MADt
0 20,000
1 21,000 20,200 20,000
2 18,000 20,200 20,200 2,200 2,200 2,200
3 20,000 20,200 20,200 200 200 1,200
4 17,000 20,200 20,200 3,200 3,200 1,867
St Dev of
20,200 Forecast Errors 2,333

MAD is computed by dividing sum of absolute errors to the cumulative number of forecasts: i.e. 1, 2,
and 3

Demand Forecast Absolute Error

Period t Dt Level Lt Ft Error Et At MADt
0 20,000
1 21,000 20,200 20,000
2 18,000 19,760 20,200 2,200 2,200 2,200
3 20,000 19,808 19,760 -240 240 1,220
4 17,000 19,246 19,808 2,808 2,808 1,749
St Dev of
19,246 Forecast Errors 2,187

Updating the forecast with the new information improves the errors in this case.