INVENTORY MANAGEMENT – SEMESTER 01 – 2022-2023

HOMEWORK 7 – SOLUTION

Question 1:
An electronics company has two contract manufacturers in Asia: Foxconn assembles its tablets
and smart phones and Flextronics assembles its laptops. Monthly demand for tablets and
smartphones is 10,000 units, whereas that for laptops is 4,000. Tablets cost the company $100,
laptops cost $400, and the company has a holding cost of 25 percent. Currently the company
has to place separate orders with Foxconn and Flextronics and receives separate shipments.
The fixed cost of each shipment is $10,000. What is the optimal order size and order frequency
with each of Foxconn and Flextronics?

SOLUTION
Foxconn:

• Monthly demand: 10,000 units => Annual demand: D = 10,000  12 = 120,000 units.
• Fixed ordering cost (for each shipment): Co = $10,000 / order.
• Cost of tablets: $100 / unit.
• Annual inventory holding cost: Ch = 25%  $100 = $25 / unit / yr.
2 × 𝐷 × 𝐶𝑂 2 × 120,000 × 10,000
• EOQ = √ 𝐶ℎ
=√ 25
= 9,797.95 𝑢𝑛𝑖𝑡𝑠 ≈ 9,798 𝑢𝑛𝑖𝑡𝑠.
• Optimal order size is 9,798 units.
𝐷 120,000
• Order frequency = 𝑄 = 9,798 = 12.25 ≈ 13 𝑜𝑟𝑑𝑒𝑟𝑠.

Flextronics:

• Monthly demand: 4,000 units => Annual demand: D = 4,000  12 = 48,000 units.
• Fixed ordering cost (for each shipment): Co = $10,000 / order.
• Cost of laptops: $400 / unit.
• Annual inventory holding cost: Ch = 25%  $400 = $100 / unit / year.
2 × 𝐷 × 𝐶𝑂 2 × 48,000 × 10,000
• EOQ = √ =√ = 3,098.39 𝑢𝑛𝑖𝑡𝑠 ≈ 3,098 𝑢𝑛𝑖𝑡𝑠.
𝐶ℎ 100
• Optimal order size is 3,098 units.
𝐷 48,000
• Order frequency = 𝑄 = 3,098 = 15.49 ≈ 16 𝑜𝑟𝑑𝑒𝑟𝑠.

Question 2:
Harley purchases components from three suppliers. Components purchased from Supplier A
are priced at $5 each and used at the rate of 20,000 units per month. Components purchased
from Supplier B are priced at $4 each and are used at the rate of 2,500 units per month.
Components purchased from Supplier C are priced at $5 each and used at the rate of 900 units
per month. Currently, Harley purchases a separate truckload from each supplier. As part of its
JIT drive, Harley has decided to aggregate purchases from the three suppliers. The trucking

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company charges a fixed cost of $400 for the truck with an additional charge of $100 for each
stop. Thus, if Harley asks for a pickup from only one supplier, the trucking company charges
$500; from two suppliers, it charges $600; and from three suppliers, it charges $700. Suggest a
replenishment strategy for Harley that minimizes annual cost. Assume a holding cost of 20
percent per year. Compare the cost of your strategy with Harley’s current strategy of ordering
separately from each supplier. What is the cycle inventory of each component at Harley?

SOLUTION
Supplier A:

• Monthly demand: 20,000 units => Annual demand: D = 20,000  12 = 240,000 units.
• Fixed ordering cost (for each shipment): Co = $500 / order.
• Cost of components: $5 / unit.
• Annual inventory holding cost: Ch = 20%  $5 = $1 / unit / year.
2 × 𝐷 × 𝐶𝑂 2 × 240,000 × 500
• EOQ = √ 𝐶ℎ
=√ 1
= 15,491.93 𝑢𝑛𝑖𝑡𝑠 ≈ 15,492 𝑢𝑛𝑖𝑡𝑠.
• Optimal order size is 15,492 units.
𝐸𝑂𝑄 𝐷 15,492 240,000
• TC𝐴 = 2 × 𝐶ℎ + 𝑄 × 𝐶𝑜 = 2 × 1 + 15,492 × 500 = $15,491.93

Supplier B:

• Monthly demand: 2,500 units => Annual demand: D = 2,500  12 = 30,000 units.
• Fixed ordering cost (for each shipment): Co = $500 / order.
• Cost of components: $4 / unit.
• Annual inventory holding cost: Ch = 20%  $4 = $0.8 / unit / year.
2 × 𝐷 × 𝐶𝑂 2 × 30,000 × 500
• EOQ = √ 𝐶ℎ
=√ 0.8
= 6,123.72 𝑢𝑛𝑖𝑡𝑠 ≈ 6,124 𝑢𝑛𝑖𝑡𝑠.
• Optimal order size is 6,124 units.
𝐸𝑂𝑄 𝐷 6,124 30,000
• TC𝐵 = × 𝐶ℎ + × 𝐶𝑜 = × 0.8 + × 500 = $5,511.38
2 𝑄 2 6,124

Supplier C:

• Monthly demand: 900 units => Annual demand: D = 900  12 = 10,800 units.
• Fixed ordering cost (for each shipment): Co = $500 / order.
• Cost of components: $5 / unit.
• Annual inventory holding cost: Ch = 20%  $5 = $1 / unit / year.
2 × 𝐷 × 𝐶𝑂 2 × 10,800 × 500
• EOQ = √ 𝐶ℎ
=√ 1
= 3,286.34 𝑢𝑛𝑖𝑡𝑠 ≈ 3,287 𝑢𝑛𝑖𝑡𝑠.
• Optimal order size is 3,287 units.
𝐸𝑂𝑄 𝐷 3,287 10,800
• 𝑇𝐶𝑐 = 2 × 𝐶ℎ + 𝑄 × 𝐶𝑜 = 2 × 1 + 3,287 × 500 = $3,286.33

• The total cost of Harley’s current strategy: TC=TCA + TCB + TCc = $24,289.64
Combine A & B: Joint order all products from supplier A and B

• The combined order cost from three supplier: 𝑆 ∗ = $600

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𝐷𝐴 ×𝐶ℎ𝐴 +𝐷𝐵 ×𝐶ℎ𝐵 240,000×1+30,000×0.8

• The optimal frequency is: 𝑛∗ = √ 2×𝑆 ∗
=√ 2×600
= 14.83 𝑜𝑟𝑑𝑒𝑟𝑠.
• Order quantity for each supplier:
𝐷 240,000
o QA = 𝑛𝐴∗ = 14.83 ≈ 16,181 𝑢𝑛𝑖𝑡𝑠.
𝐷𝐵 30,000
o QB = 𝑛∗
= 14.83
≈ 2,023 𝑢𝑛𝑖𝑡𝑠.
• Cycle inventory for each component:
𝑄𝐴
o Supplier A: 2
= 8,091 units.
𝑄𝐵
o Supplier B: = 1,012 units
2
𝑄𝐶
o Supplier C: = 1,643.5 units.
2

• Holding cost for this strategy:

𝑄𝐴 × 𝐶ℎ𝐴 + 𝑄𝐵 × 𝐶ℎ𝐵 + 𝑄𝐶 × 𝐶ℎ𝐶 16,181 × 1 + 2,023 × 0.8 + 3,287 × 1
= = $10,543.2
2 2
• Total cost = Holding cost + Ordering cost = $10,543.2 + $14.83600 + $1,642.84=
$21,805.47
Combine A & C: Joint order all products from supplier A and C

• The combined order cost from three supplier: 𝑆 ∗ = $600

𝐷𝐴 ×𝐶ℎ𝐴 +𝐷𝐶 ×𝐶ℎ𝐶 240,000×1+10,800×1
• The optimal frequency is: 𝑛∗ = √ =√ = 14.45 𝑜𝑟𝑑𝑒𝑟𝑠.
2×𝑆 ∗ 2×600
• Order quantity for each supplier:
𝐷 240,000
o QA = 𝑛𝐴∗ = 14.45 ≈ 16,602 𝑢𝑛𝑖𝑡𝑠.
𝐷𝐶 10,800
o QC = = ≈ 748 𝑢𝑛𝑖𝑡𝑠.
𝑛∗ 14.45
• Cycle inventory for each component:
𝑄𝐴
o Supplier A: 2
= 8,301 units.
𝑄𝐵
o Supplier B: 2
= 3,062 units
𝑄𝐶
o Supplier C: 2
= 374 units.

• Total cost = Holding cost + Ordering cost = $22,248.08

Combine B & C: Joint order all products from supplier B and C

• The combined order cost from three supplier: 𝑆 ∗ = $600

𝐷𝐵 ×𝐶ℎ𝐵 +𝐷𝐶 ×𝐶ℎ𝐶
• The optimal frequency is: 𝑛∗ = √ 2×𝑆 ∗
= 5.39 𝑜𝑟𝑑𝑒𝑟𝑠.
• Order quantity for each supplier:
𝐷
o QB = 𝑛𝐵∗ ≈ 5,571 𝑢𝑛𝑖𝑡𝑠.
𝐷𝐶
o QC = 𝑛∗
≈ 2,006 𝑢𝑛𝑖𝑡𝑠.

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• Cycle inventory for each component:

𝑄𝐴
o Supplier A: 2
= 7,746 units.
𝑄𝐵
o Supplier B: 2
= 2,786 units
𝑄𝐶
o Supplier C: 2
= 1,003 units.

• Total cost = Holding cost + Ordering cost = $21,954.43

Combine all: Joint order all products from supplier A, B, C

• The combined order cost from three supplier: 𝑆 ∗ = $700

𝐷𝐴 ×𝐶ℎ𝐴 +𝐷𝐵 ×𝐶ℎ𝐵 +𝐷𝐶 ×𝐶ℎ𝐶 240,000+30,000×0.8+10,800
• The optimal frequency is: 𝑛∗∗ = √ 2×𝑆 ∗∗
=√ 2×700
=
14.01 𝑜𝑟𝑑𝑒𝑟𝑠.
• Order quantity for each supplier:
𝐷 240,000
o QA = 𝑛∗∗𝐴 = 14.01 = 17,130.62 ≈ 17,131 𝑢𝑛𝑖𝑡𝑠.
𝐵𝐷 30,000
o QB = 𝑛∗∗ = 14.01
= 2,141.32 ≈ 2,142 𝑢𝑛𝑖𝑡𝑠.
𝐷𝐶 10,800
o QC = = = 770.88 ≈ 771 𝑢𝑛𝑖𝑡𝑠.
𝑛∗∗ 14.01
• Cycle inventory for each component:
𝑄𝐴
o Supplier A: 2
= 8,565.5 units.
𝑄𝐵
o Supplier B: = 1,071 units
2
𝑄𝐵
o Supplier C: 2
= 335,5 units.

• Holding cost for this strategy:

𝑄𝐴 × 𝐶ℎ𝐴 + 𝑄𝐵 × 𝐶ℎ𝐵 + 𝑄𝐶 × 𝐶ℎ𝐶 17,131 × 1 + 2,142 × 0.8 + 771 × 1
= = $9,807.8
2 2
• Total cost = Holding cost + Ordering cost = 9,807.8 + 14.01700 = $19,614.8
SUMMARY
Disaggregate A+B A+C B+C A+B+C

TC $23,677.25 $21,085.47 $22,248.08 $21,954.43 $19,614.94

Conclusion: Choose option aggregated all suppliers.

Question 3:
A BMW dealership has k = 4 retail outlets serving the entire Chicago area (disaggregate
option). Weekly demand at each outlet is normally distributed, with a mean of D = 25 cars and a
standard deviation of D = 5. The lead time for replenishment from the manufacturer is L = 2
weeks. Each outlet covers a separate geographic area, and the correlation of demand across
any pair of areas is ρ. The dealership is considering the possibility of replacing the four outlets

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with a single large outlet (aggregate option). Assume that the demand in the central outlet is the
sum of the demand across all four areas. The dealership is targeting a CSL of 0.90. Compare
the level of safety inventory needed in the two options as the correlation coefficient for the
following cases:

• Case 1: ρ = 0
• Case 2: ρ = 0.8
• Case 3: ρ = 1
• Case 4: ρ = −0.6

SOLUTION

Disaggregate option:

• 𝐷 = 25 𝑐𝑎𝑟𝑠.
• 𝐿 = 2 𝑤𝑒𝑒𝑘𝑠.
• 𝐷 = 5
• 𝜎𝐿 = 𝜎𝐷 × √𝐿 = 5 × √2 = 7.07
• 𝑃 = 0.9 => 𝑧 = 1.28
• 𝑆𝑆 = 𝑧 × 𝜎𝐿 = 1.28 × 7.07 = 9.05 𝑐𝑎𝑟𝑠.
• 𝑇𝑜𝑡𝑎𝑙 𝑠𝑎𝑓𝑒𝑡𝑦 𝑠𝑡𝑜𝑐𝑘 = 4 × 𝑆𝑆 = 4 × 9.05 = 36.2 ≈ 37 𝑐𝑎𝑟𝑠.

Aggregate option:

𝐷 = 25 × 4 = 100 𝑐𝑎𝑟𝑠.

• Case 1:  = 0

o 𝜎𝐷 = √52 + 52 + 52 + 52 + 2 × 𝜌 × 5 × 5 × 𝐶42 = 10
o 𝐿 = 2 𝑤𝑒𝑒𝑘𝑠
o 𝜎𝐿 = 𝜎𝐷 × √𝐿 = 10 × √2 = 14.14
o 𝑃 = 0.9 => 𝑧 = 1.28
o 𝑆𝑆 = 𝑧 × 𝜎𝐿 = 1.28 × 14.14 = 18.1 ≈ 19 𝑐𝑎𝑟𝑠.

This case gives smaller in safety stock than disaggregate option.

• Case 2:  = 0.8

o 𝜎𝐷 = √52 + 52 + 52 + 52 + 2 × 𝜌 × 5 × 5 × 𝐶42 = 18.44

o 𝐿 = 2 𝑤𝑒𝑒𝑘𝑠
o 𝜎𝐿 = 𝜎𝐷 × √𝐿 = 18.44 × √2 = 26.08
o 𝑃 = 0.9 => 𝑧 = 1.28
o 𝑆𝑆 = 𝑧 × 𝜎𝐿 = 1.28 × 26.08 = 33.38 ≈ 34 𝑐𝑎𝑟𝑠

This case gives smaller in safety stock than disaggregate option.

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• Case 3:  = 1

o 𝜎𝐷 = √52 + 52 + 52 + 52 + 2 × 𝜌 × 5 × 5 × 𝐶42 = 20
o 𝐿 = 2 𝑤𝑒𝑒𝑘𝑠
o 𝜎𝐿 = 𝜎𝐷 × √𝐿 = 20 × √2 = 28.28
o 𝑃 = 0.9 => 𝑧 = 1.28
o 𝑆𝑆 = 𝑧 × 𝜎𝐿 = 1.28 × 28.28 = 36.20 ≈ 37 𝑐𝑎𝑟𝑠

This case gives the same safety stock as disaggregate option, which means this case is
disaggregate option.

• Case 4:  = -0.6

o 𝜎𝐷 = √52 + 52 + 52 + 52 + 2 × 𝜌 × 5 × 5 × 𝐶42 = √−80

We cannot compute safety stock for this case.

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