Inventory and Materials Manaement

Inventory and Materials
Management
Anot Chaimanee, D.Eng. 1

Outlines
Inventory Management
Independent Demand Systems Independent Demand Systems

Discrete Demand Systems
(Deterministic Models) (Probabilistic Model)
Lot-For-Lot Ordering Economic Order Quantity (EOQ) EOQ

Wagner-Whitin Algorithm EOQ with discount Service Level (Probability of Shortage)
Silver-Meal Algorithm EOQ with backordering Reorder Point
Periodic Order Quantity Economic Production Quantity (EPQ) Safety Stock
Least Unit Cost Economic Order Interval (EOI) EOI
Part-Period Algorithm Maximum inventory level (Emax)
Incremental Part-Period Algorithm
Implication for Discrete Lot Sizing Simulation
Discrete Demand Systems, Deterministic Model
R5
R1 R7
R2 R3
R4
R6
1 2 3 4 5 6 7
◼ Demand occurs at discrete equal intervals

◼ Finite horizon
◼ Hard to solve (NP-Complete) – use dynamic programming (Wagner-
Within) to find the optimal solution
◼ Heuristics are used to find approximate solutions
Discrete Demand Systems, Deterministic Model
Assumption
◼ Known and variable demands that occur at the beginning of period
◼ Finite horizon with period are equal length
◼ Lot sizes = demand for one or more subsequent periods
◼ All replenishment arrive at the beginning of period
◼ No shortage or stock-outs
◼ Independent items
◼ No quantity discount
◼ Inventory at the beginning and end of horizon is zero
Lot-For-Lot Ordering
◼ An order is scheduled for each period in which a demand
occurs.
◼ Items are purchased in the exact quantities required for each
period, so no items are held over from period to period.
◼ This approach eliminates the inventory holding cost.
◼ On the other hand, LFL ignores order (setup) cost and involves
many different order sizes.

Wagner-Within Algorithm
◼ Wagner-Within Algorithm
◼ Use dynamic programming procedure
◼ Obtain the optimal solution
◼ Let R1, R2,…, RN denote the demand in periods 1, 2, …, N. The problem is to

determine the lot sizes Q1, Q2, …, Q3 which the minimize the sum of
procurement costs and inventory costs over the N period.
R7
R1 R2 R3 R5 R 6
1 2 3 4 5 6 7
Q5
Q7
Anot Chaimanee, D.Eng. Q1 6
◼ Define Zjk to be the total cost in periods j through k of placing an order
in period j which satisfies demands in periods j through k.
 k  k −1  k 
Z jk = Pj   Ri  + C j +  ht   Ri 
 i= j  t = j  i =t +1 
 
0
◼ Define fk to be the minimum possible cost in periods 1 through k, given
that the inventory level at the end of period k is zero.
f0 = 0
fk = min (Zjk+fj-1)
◼ Solution: fN
◼ Example Wagner-Within Algorithm
t 1 2 3 4
Rt 60 100 140 200
Ct 150 140 160 160
Pt 7 7 8 7
ht 1 1 2 2
Z1,1 = P1R1 + C1 = 7(60) + 150 = 570
Z1,2 = P1(R1+R2) + C1 + h1(R2) = 7(60+100) + 150 + 1(100) = 1370
Z1,3 = P1(R1+R2+R3) + C1 + h1(R2+R3) + h2(R3) = 2630
Z1,4 = P1(R1+R2+R3+R4) + C1 + h1(R2+R3+R4) + h2(R3+R4)+h3(R4) = 4830
◼ Example Wagner-Within Algorithm (cont.)
t 1 2 3 4
Rt 60 100 140 200
Ct 150 140 160 160
Pt 7 7 8 7
ht 1 1 2 2
Z2,2 = P2R2 + C2 = 7(100) + 140 = 840
Z2,3 = P2(R2+R3) + C2 + h2(R3) = 7(100+140) + 140 + 1(140) = 1960
Z2,4 = P2(R2+R3+R4) + C2 + h2(R3+R4) + h3(R4) = 3960
Z3,3 = P3R3 + C3 = 8(140) + 160 = 1280
Z3,4 = P3(R3+ R4) + C3 + h3(R4) = 3280
Z4,4 = P4R4 + C4 = 7(200) + 160 = 1560
t 1 2 3 4
Rt 60 100 140 200 f4 = 4090
Ct 150 140 160 160 Produce in period 4 for demand in period 4
Pt 7 7 8 7 Produce in period 2 for demand in period 2 and 3
ht 1 1 2 2
Produce in period 1 for demand in period 1
Z1,1 = 570 f0 = 0
Z1,2 = 1370 f1 = Z1,1 + f0 =570
Z1,3 = 2630 f2 = min Z1,2+f0 = 1370
Z1,4 = 4830 Z2,2+f1 = 840 + 570 = 1410
Z2,2 = 840 f3 = min Z1,3+f0 = 2630
Z2,3 = 1960 Z2,3+f1 = 1960 + 570 = 2530
Z2,4 = 3960 Z3,3+f2 = 1280 + 1370 = 2650
Z3,3 = 1280 f4 = min Z1,4+f0 = 4830
Z3,4 = 3280 Z2,4+f1 = 3960 + 570 = 4530
Z4,4 = 1560 Z3,4+f2 = 3280 + 1370 = 4650
Anot Chaimanee, D.Eng. Z4,4+f3 = 1560 + 2530 = 4090 10
Modified EOQ Model
◼ Procedure
◼ For constant P, C, and H.
◼ First find Q for the EOQ using average demand.
◼ Find Q* by comparing total demand for a number of periods with

Q from EOQ

Modified EOQ Model
Example
R1 R2 R3 R4 R5 R6 R7 R8 R9 R10 R11 R12
10 62 12 130 154 129 88 52 124 160 238 41
Pj = P = $20/unit, Cj= C = $54, Hj = H =$0.40/unit/month
12
σ 𝐷 2𝐶 𝑅ത 2(54)(100)
𝑅ത = 𝑡=1 𝑡 = 100 unit/month, 𝑄 = = = 164
12 ℎ 0.4
R1= 10 <164
R1+ R2 = 10 + 62 = 72 <164
R1+ R2 + R3 = 10 + 62 + 12 = 84 <164
R1+ R2 + R3 + R4= 10 + 62 + 12 + 130 = 214 >164 (Stop)
214 is closer to the Q → 𝑄1∗ = R1+ R2 + R3 + R4 = 214
Start again with time 5
Q1 = 214, Q5 = 214, Q6 = 129, Q7 = 140, Q9 = 124, Q10 = 160, Q11 = 238, Q12 = 41
Silver Meal Method
◼ Procedure
◼ For constant P, C, and H.
◼ Determine average cost per period.
◼ Order for first period with a positive net requirement and all successive periods
where the average cost per period first increases.
𝑇𝑅𝐶(𝑇) 𝐶 + 𝑃ℎ σ𝑇𝑘=1(𝑘 − 1)𝑅𝑘
=
𝑇 𝑇
Where C = ordering cost per order
h = holding cost fraction per period
P = unit purchase cost
H = Ph = holding cost per period
TRC(T) = total relevant cost over T periods
T = time supply of the replenishment in periods
Rk = demand rate in period k
Silver Meal Method
◼ Procedure
◼ The objective is to select T to minimize the total relevant cost per period. The
heuristic evaluates increased value of T until
𝑇𝑅𝐶(𝑇 + 1) 𝑇𝑅𝐶(𝑇)
>
𝑇+1 𝑇
◼ The replenishment quantity Q associated with a particular value of T is

𝑇
𝑄 = ෍ 𝑅𝑘
𝑘=1

Silver Meal Method
Example
R1 R2 R3 R4 R5 R6 R7 R8 R9 R10 R11 R12
10 62 12 130 154 129 88 52 124 160 238 41
t=1
𝐶
Average cost/1 period = = 54
1
𝐶+𝐻𝑅2
Average cost/2 period = = 39.4 < 54
2
𝐶+𝐻(𝑅2 +2𝑅3 )
Average cost/3 period = = 29.5 < 39.4
3
𝐶+𝐻(𝑅2 +2𝑅3 +3𝑅4 )
Average cost/4 period = = 61.1 > 29.5 (Stop)
4
Since average cost over 4 periods is greater, we only produce over 3 periods.
Start again at time t = 4
Solution : Q1 = 84, Q4 = 130, Q5 = 283, Q7 = 140, Q9 = 124, Q10 = 160, Q11 = 273
Least Unit Cost
◼ Procedure
◼ Same as Silver-Meal except that the denominator is the total demand up to the
period considered.
◼ A replenishment order is planed when the average cost per unit first increases.
◼ If an order arrives at the beginning of the first period and covers requirement
through the end of Tth period, the total relevant cost per unit is
𝑇𝑅𝐶(𝑇) 𝐶 + 𝑃ℎ σ𝑇𝑘=1(𝑘 − 1)𝑅𝑘

=
σ𝑇𝑘=1 𝑅𝑘 σ𝑇𝑘=1 𝑅𝑘
◼ The replenishment quantity is

𝑇
𝑄 = ෍ 𝑅𝑘
𝑘=1

Least Unit Cost
Example
R1 R2 R3 R4 R5 R6 R7 R8 R9 R10 R11 R12
10 62 12 130 154 129 88 52 124 160 238 41
t=1
𝐶
Average cost/1 period = = 5.4
𝑅1
𝐶+𝐻𝑅2
𝑅1 +𝑅2
𝐶+𝐻(𝑅2 +2𝑅3 )
𝑅1 +𝑅2 +𝑅3
𝐶+𝐻(𝑅2 +2𝑅3 +3𝑅4 )
Average cost/4 period = = 1.14 > 1.05 (Stop)
𝑅1 +𝑅2 +𝑅3 +𝑅4
Since average cost over 4 periods is greater, we only produce over 3 periods.
Solution : Q1 = 84,
Part-Period Algorithm
◼

Example
Part-Period Algorithm
R1 R2 R3 R4 R5 R6 R7 R8 R9 R10 R11 R12
10 62 12 130 154 129 88 52 124 160 238 41
Pj = P =$20/unit, Cj= C = $54, hj= h = $0.40/unit/month, C/h = 135

t=1
0(R1) = 0 < 135
0(R1) + 1(R2) = 62 < 135
0(R1) + 1(R2) + 2(R3) = 86 < 135
0(R1) + 1(R2) + 2(R3) + 3 (R4) = 476 > 135 (Stop)
Solution : Q1 = 84, Q4 = 130, Q5 = 283, Q7 = 140, Q9 = 124, Q10 = 160, Q11 = 279

Single Order Quantity
◼ Christmas tree or newsboy problem
◼ Only one replenishment opportunity exists
◼ Items with a limited useful life because of supply and demand

limitation
◼ Procured at beginning of period and no chance for
replenishment

Types of Problem
◼ Known Demand, Known Lead time
◼ Known Demand, Variable Lead time
◼ Variable Demand, Known Lead time
◼ Variable Demand, Variable Lead time

◼ Known Demand, Known Lead Time
◼ Simplest: know how many (Q) and when to order
◼ Perfect planning is possible

◼ Known Demand, Variable Lead time
◼ Know how much to order (Q)
◼ Use lead time that fits goal

◼ Example II The Norfolk Boys club plans to sell Christmas trees for the building
fund. Local merchants have placed with the earliest lot on 1 December. When
should the order be placed if an 85% chance that tree arriving on time is desired.
The lead time distribution is given below.
Lead Time (days) Number of occurrences
10 10
11 10
12 15
13 20
14 30
15 10
16 5
100
Lead Time (days) Number of Occurrences Probability of occurrences Probability of lead time < L
10 10 0.10 0.10
11 10 0.10 0.20
12 15 0.15 0.35
13 20 0.20 0.55
14 30 0.30 0.85
15 10 0.10 0.95
16 5 0.05 1.00
100
◼ To satisfy all demand, the largest lead time of 16 days would be selected.
◼ If 85% chance of tree arriving on time is desired, the lead time must be 14 days.
In this case the trees should be ordered 14 days prior to 1 December.
◼ Variable Demand, Known Lead Time
◼ Know when to order and want to find how many to order (Q)
◼ Assume demand (M) is a random variable with known

density function, f(M), for continuous case or known
probability mass function P(M) for discrete case.
◼ Use decision making under risk (evaluate expected costs and
find policy that yields the maximum expected cost)

Define
◼ CO: cost per unit of positive inventory remaining at end of period
(overage cost)
◼ CU: cost per unit of unsatisfied demand (underage cost)
◼ F(Q*): critical ratio, which can be calculated as
F(Q*)= CU /(CO+CU)

◼ Example III A merchant wishes to stock Christmas tree for sale during the
Christmas season. There is only enough time for single order. Each tree costs
$2.00 and sells for $6.00. Unsold trees can be sold for $1.00 as firewood. The
merchant must order trees in multiple of ten, and the demand distribution during
the season is given below.
Demand (M) Probability P(M)
10 0.1
20 0.1
30 0.2
40 0.35
50 0.15
60 0.1
Probability 0.1 0.1 0.2 0.35 0.15 0.1 Expected
Strategy State of
10 20 30 40 50 60 Value
Nature
10 40 40 40 40 40 40 $40
20 30 80 80 80 80 80 $75
30 20 70 120 120 120 120 $105
40 10 60 110 160 160 160 $125
50 0 50 100 150 200 200 $127.50
60 -10 40 90 140 190 240 $122.50
◼ The best strategy is to order 50 trees with the expected value of $127.50

Single Order Quantities
◼ Example IV A farm boy would like to determine how many bottles of
milk he should buy for daily selling. A bottle of milk cost $0.15. The
boy can sell it with the price of $0.25. Each bottle has the disposal cost
of $0.03 by the end of the day if the boy cannot sell it. Given that the
demand distribution is U(0,300).
◼ Solution: CU = S-c = $0.25-$0.15 = $0.10
CO = c+h = $0.15+$0.03 = $0.18
F(Q*) = CU/ (CU+CO) = 0.10/ (0.10+0.18) = $0.357

◼ Solution:
A = 0.357
Q* = 0.357(300) = 107
1/300
0 107 300

◼ Variable Demand, Variable Lead Time
◼ When both demand and lead time are variable, the problem
is more complex.
◼ It is possible to treat demand and lead time as independent
variables.
◼ The demand can be determined independently of the lead
time, as in the variable demand, constant lead time case.
The lead time can be set at its maximum level or at some
acceptable level.
Dependent Demand Systems: Material Requirement Planning
Material Requirement Planning (MRP)
◼ Developed to help manufacturing organizations cope better with their
dependent demand items
◼ Also, known as “time-phrased requirement planning”
◼ Designed to
◼ Release production and purchase orders to regulate the flow of raw material
and in-process inventories necessary to meet the production schedules for
finished product.
◼ Ensure the availability of materials, components, and products for planned
production and customer delivery.
◼ Maintain minimum levels of dependent demand items.

◼ MRP Inputs
MASTER PRODUCTION SCHEDULE (MPS)
(Indicates products to produce and when they are need)
INVENTORY STATUS RECORDS PRODUCT STRUCTURE RECORDS

(Contains on-hand balances, open orders, (Contains bill of materials and show
lot size, lead times, and safety stocks) how product is produced
MATERIAL REQUIREMENT PLANNING (MRP)

(Explodes BOM and MPS requirements, nets out inventory
levels, offsets lead times, and issue reports on
(1) What to order and how many, (2) when to order,
(3) what order to expedite, de-expedite, or cancel
◼ MRP Outputs
MRP
Planned Order Release
Purchase orders (PO) Work orders (WO) Reschedule notices (RN)

◼ Example
Lot Lead On Safety Allo- Level Period

Item
Size Time Hand Stock cated Code PD 1 2 3 4 5 6 7 8
Gross Req. 10 15 25 25 30 45 20 30
Sched. Receipt 10 25
25 2 10 0 0 1 z Proj-on-hand 10 10 20 20 20 15 0 5 0
Net Req. 0 0 5 5 10 30 20 25
PO Receipt 25 25 25 30 25 25
PO Release 25 25 25 30 25 25

◼ Example
A Q
LT = 4 LT = 2
B(1) C(2) C(1) E(1)

LT = 3 LT = 2 LT = 2 LT = 1
D(1) E(2) D(1) E(2)

LT = 1 LT =1 LT = 1 LT = 1

Item
Gross Req. 103
Sched. Receipt
1 4 18 5 10 0 A Proj-on-hand 3 3 3 3 3 3 3 3 0
Net Req.
PO Receipt 100
PO Release 100
Gross Req. 200
Sched. Receipt
1 2 6 6 0 0 Q Proj-on-hand 0 0 0 0 0 0 0 0
Net Req. 200
PO Receipt 200
PO Release 200

Item
Gross Req. 100
Sched. Receipt
1 3 10 0 0 1 B Proj-on-hand 10 10 10 10 0
Net Req. 90
PO Receipt 90
PO Release 90
Gross Req. 200 200
Sched. Receipt
1 2 20 0 0 1 C Proj-on-hand 20 20 20 20 0 0
Net Req. 180 200
PO Receipt 180 200
PO Release 180 200

Item
Gross Req. 180 200
Sched. Receipt
200 1 0 0 0 2 D Proj-on-hand 0 0 20 20
Net Req. 180 180
PO Receipt 200 200
PO Release 200 200
Gross Req. 360 400 200
Sched. Receipt
500 1 30 0 0 2 E Proj-on-hand 30 30 170 270 270 70
Net Req. 330 230 0
PO Receipt 500 500
PO Release 500 500

Inventory Fundamentals
◼ Inventory: Material held in an idle or incomplete state awaiting for
future sale, use, or transformation.
◼ Type of inventory
◼ Supplies
◼ Raw Material
◼ Work- in – process
◼ Finish good
◼ Pipe-line
Asst. Prof. Anot Chaimanee, D.Eng. 41

Acquisition Distribution
Supplier Inventory Customer
Inventory policy contains two questions
System When to Order? How much to Order?
Order Quantity B Q=R×T
Periodic T = Q/D Q=R×T
Where
Q = Lot Size or Order Quantity
R = Demand/year
T = Inventory Period or Time between orders
B = Reorder Point
◼ Given ◼ Relationship
Q = 300, R = 1300 items/year, T = 13 weeks Q = R × T = 25 × 13 = 325
Time Standard 1 year 4 quarters 12 months 52 weeks
Demand = 1300 items/year 1300/yr 325/qtr 108.33/mo 25/wk
Inventory Period =13 weeks 0.25 years 1 quarter 3 months 13 weeks
System When to Order? How much to Order? Policy
Order B=0 Q = R × T =325 (B, Q) = (0, 325)
Quantity When inventory is 0 order 325.
Periodic T = Q/R =13 weeks Q = R × T = 325 (T, Q) = (13 weeks, 325)
Every 13 weeks order 325.
◼ Given ◼ Relationship
Q = 300, R = 1300 items/year, T = 13 weeks Q = R × T = 25 × 13 = 325
Sawtooth Curve, Q = R×T
325
Inventory level
Time
13 26 39 52
The annual planning horizon
- Order Frequency = F = 4 orders/year, F = R/Q
- Q = R×T , Q = R/F thus T = 1/F and F = 1/T
Inventory Turnover = R
- Inventory Turnover Rate = R/(Q/2)=2(R/Q)=2F
Example Review System
Demand is 6984/year. The inventory period is one Order Quantity .Periodic
month. The reorder point is 0. What is the lot size (B, Q) (T, Q)
Answer: Q = R × T = (6984/12) ×(1) = 582 (0, 582) (1 month, 582)
Source: Harper Classroom

Demand = 6984 items/year 6984/yr 1746/qtr 582/mo 134.31/wk
Inventory Period =1 month 1/12 years 1/3 quarter 1 months 52/12 weeks
Source: Harper Classroom

Inventory Fundamentals, Reorder Point (B)
Acquisition Distribution
Supplier Inventory Customer
Definition Given Policy
R = Demand/year R = 1300 items/year, Q = 325 items, T = 13 week
L = Lead time L = 2 weeks B = (R × L)+5 = 25 × 2 = 55
SS = Safety stock SS = 5 items note: if SS = 0, B = 50
System When to Order? How much to Order? Policy
Order B = 55 Q = 325 (B, Q) = (55, 325)
Quantity When inventory is 55 order 325.
Demand = 1300 items/year 1300/yr 325/qtr 108.33/mo 25/wk
Lead Time =2 weeks 2/52 years (2×4)/52 quarter (2×12)/52 months 2 weeks
Policy
Q = 325 items, L = 2 weeks, SS = 0
B = (R × L)+0 = (25 × 2)+0 = 50
note: if SS = 0, B = 50
Sawtooth Curve, SS=0
325
Inventory level
50
Time
11 13 26 39 52
Policy
Q = 325 items, L = 2 weeks, SS = 5 Safety stock is decided by
B = (R × L)+0 = (25 × 2)+5 = 55 probability of stockout = α (Service level = 1- α)
Sawtooth Curve, SS=5
325
Inventory level
55
5 Time
Asst. Prof. Anot Chaimanee, D.Eng. 11 13 26 39 52 47
Inventory model
Deterministic
◼ Deterministic Model: Demand and lead time are treated as
constants.
Assumption
1. The demand is known, uniform, and continuous.
2. The production rate is known, uniform, and continuous.
3. The lead time is known and constant.
4. The order/setup cost is known and constant.
5. The holding cost is known, constant, and linear.
6. There are no resource limitations (money limits or space limits).
7. Stockouts are usually not permitted (infinite stockout cost).
8. The cost of the inventory analysis is negligible.
Inventory model
Deterministic
◼ To determine an optimal inventory policy, information on each of the

following parameters is required
1. Demand,
2. Appropriate inventory costs.
3. Lead time.

Inventory model
Deterministic
◼ Inventory Cost
◼ Purchase cost (P) of an item is the unit purchase price if it is obtained from
an external source, or the unit production cost if it is produced internally.
◼ Order/Set up Cost (C) originates from the expense of issuing a purchase
order to an outside supplier or from internal production setup costs.
◼ Holding Cost (H), synonymous with carrying cost, subsumes the costs
associated with investing in inventory and maintaining the physical
investment in storage.
◼ Stockout Cost (depletion cost) is the economic consequence of an external or
internal shortage.

Inventory model
Deterministic
◼ An external shortage occurs when a customer’s order

is not filled
◼ An internal shortage occurs when an order of a group
or dependent within the organization is not filled.

Inventory model
Deterministic
◼ Type of demand
◼ Independent demand: no relationship exists between the demand
for an item and for any other item (i.e., end items, finished
products).
◼ Dependent demand: The demand for an item is “higher level” item
(i.e., raw materials, components, and subassemblies).

Inventory model
Deterministic
◼ Parameters and Notations
◼ P = unit price cost ($/unit)
◼ C = setup or order cost ($/order)
◼ H = Inventory holding cost ($/unit/year).
Sometime, H = fP, where h is the annual factor associated with capital
costs, taxes, insurance, etc.
◼ R = demand rate (units/year)
◼ Q = order quantity (units)
◼ T = time between order arrivals
◼ F = number of orders during the year
◼ L = order lead time (year)
◼ B = reorder point
Economic Order Quantity (EOQ) Model
Deterministic
◼ Assumption (Recall)
◼ Single item
◼ The demand rate is known, constant, and continuous
◼ The order quantity, Q, is a continuous variable
◼ Entire lot is added to inventory at the same time
◼ P, C, H ≥ 0 and are constants
◼ Order lead time is known and constant
◼ No shortage or backorder is allowed
◼ Infinite planning horizon
◼ Sufficient space, capacity, and capital

Deterministic
Inventory level
T L Time
Total annual cost = purchase cost + order cost + holding cost

R 1
TC (Q) = PR + C + HQ
Q 2

Deterministic
Cost
Total cost
Minimum cost
Purchasing cost
Optimum level Inventory level

dTC (Q) R 1 2CR
= −C 2 + H = 0 Q* = TC (Q* ) = PR + HQ*
dQ Q 2 H

Deterministic
Example 1 : Demand for the computer is 1,000 units per month. The store incurs the order
placement, transportation, and receiving cost of $4,000 each time an order is placed. Each
computer costs the store $500 and the retailer has a holding cost of 20 percent. Evaluate the
number of computers that the store manager should order in each replenishment lot.
Solution: R = 1,000×12 = 12,000 computers per year, P = $500, f = 0.2, C = $4,000/order
2(4000)(12,000)
Q* = = 980 computers
(0.2  500)
Cycle Inventory = Q * / 2 = 490 computers

c
Average Flow Time = Q * / 2 R = 490 /12,000 = 0.041 years = 0.49 months
Reorder Interval = T = 0.98 months

Deterministic
Example 2 : The PUPE Manufacturing Company purchases 8000 units of a product each year at a
unit cost of $10.00. The order cost is $30.00 per order, and the holding cost per unit per year is
$3.00. What are the economic order quantity, the total annual cost, the number of order to place in
one year, and the reorder point when the lead time is two weeks?
Solution: P = 10, R = 8,000, C = 30, H = 3
Q* = 2 ( 30 )(8000 ) / 3 = 400
TC ( Q *) = 10 (8, 000 ) + 3 ( 400 ) = $81, 200

c
F = 8,000/400 = 20
ROP = (8,000)(2)/52 = 307.7

Deterministic
Example 3 : The three-ohm resistor is used in the assembly of an automated
processor of X-ray film. The demand for this item has been relatively level over time
at a rate of 2400 units/year. The unit cost of the resistor is $0.40 and the fixed cost
per replenishment is estimated to be $3.20. Suppose that the holding cost fraction of
0.24 $/$/year is approximate to use.
Solution P = 0.40, R = 2,400, C = 3.20, H = 0.40*0.24
Q* = 2 ( 3.20 )( 2400 ) / ( 0.4  0.24 ) = 400

c
TC ( Q *) = 0.40 ( 2, 400 ) + ( 0.4  0.24  400 ) = $998.4

EOQ Model with All-Units Quantity Discounts
Deterministic
◼ Lower per unit price for the entire lot
P0 for U0 ≤ Q < U1
Pi = P1 for U1 ≤ Q < U2
Pj for U0 ≤ Q < α

Deterministic
Cost TC Case 1
TC
fPQ
Case 2
2
P0
P1
P2 CR
TC
Q Case 3
U1 U2 Quantity

Deterministic
◼ Calculation Procedure
Step 1: Starting with the lowest unit cost, calculate the EOQ at each unit cost
until the valid EOQ is obtained.
Step 2 :Calculate the total annual cost for valid EOQ and all price-break
quantities larger than the valid EOQ.
◼ A price-break quantity for which the price discount is available.
Step 3: Select the quantity with the lowest total cost in step 2.

Deterministic
◼ Example 4 : The Smith Company purchases 300,000 units of product
per year. The supplier offers the units for sale at different values as
follow.
0 ≤ Q0 < 10,000 $ 1.00
10,000 ≤ Q1 < 30,000 $ 0.98
30,000 ≤ Q2 < 50,000 $ 0.96
50,000 ≤ Q3 < $ 0.94
◼ What is the economic order quantity if the order cost is $100.00 per
order, the holding cost factor is 20% of per unit cost and the cost of
warehouse storage is $0.10/mouth/unit?
Deterministic
◼ Solution:
TC(Qi) = PiR + CR/Q + Pi fQ/2
= Pi(300,000) + 100(300,000)/Q + (0.20Pi + 1.20)Q/2
2 × 100 × 300,000
Qi =
0.2Pi + 1.20
Q3 = 6574.78 < 50,000 Q3*= 50,000 TC(50,000) = 317,300

Q2 = 6565.32 < 30,000 Q2* = 30,000 TC(30,000) = $309880
Q1 = 6555.91 < 10,000 Q1* = 10,000 TC(10,000) = $303980
Q0 = 6546.54 Q0* = 6,546.54 TC(6,550) = $309165.2
EOQ Model with Incremental-Units Quantity Discounts
Deterministic
◼ The lower unit price only apply to quantities in the particular discount
level.
P0 for each U0 to U1- 1
Pi = P1 for each of the next U1 to U2-1
Pj for each of the next Uj to α

Deterministic
 D R  D  fQ
TC (Q) =  Pi + i  R + C +  Pi + i 
 Q Q  Q 2
dTC (Q) (C + Di ) R Pi f
=− 2
+ =0
dQ Q 2
Q* = 2 R(C + Di ) / Pi f
Source : Supithak (Handout)

Deterministic
◼ Calculation Procedure
◼ Calculate the EOQ for each unit purchase cost.
◼ Determine which EOQs are valid.
◼ Calculate the total cost for each valid EOQ.
◼ Select the valid EOQ with the lowest total cost.

Deterministic
◼ Example 5 : The annual demand for an item is 4,800 units, the

ordering cost is $40 per order, and the annual holding cost fraction is
0.25, what is the optimum lot size if the firm faces the incremental
discount schedule below?
Lot Size Unit Price
< 400 $10.00
400 – 1,199 $9.00
1,200 – 4,799 $8.50
> 4,799 $8.00
Deterministic
◼ Solution
i Pi Ui Di
0 $10.00 1 0
1 $9.00 400 399($10.00-$9.00) = 399.00
2 $8.50 1200 399 + 1199($9.00-$8.50) = 998.50
3 $8.00 4800 998.50 + 4799($8.50-$8.00) = 3398.00
2(4800)(40 + 0)
Q0* = = 392
10(0.25)
2(4800)(40 + 399) not valid

Q1* = = 1369
9(0.25)
c
2(4800)(40 + 998.50)
Q2* = = 2166
8.50(0.25)
2(4800)(40 + 3398)
Q3* = = 4062 not valid 69
8(0.25)
EOQ Model with Backordering Cost
Deterministic
Inventory Level
Q -J
Q t2
Time
J t1
t3
◼ Holding cost for one cycle: ½ H(Q-J)t1 = H(Q-J)2/2R
◼ Stockout cost for one cycle: ½ K(J)t2 = KJ2/2R
◼ Total cost for one cycle: PQ + C +[H(Q-J)2/2R] + KJ2/2R
Deterministic
Total annual cost:  2 

H (Q − J ) 2
KJ R
◼ TC (Q, J ) =  PQ + C +
 2R
+
2 R  Q

 R H (Q − J ) 2
KJ 2 
CR HQ HJ 2
KJ 2
TC (Q, J ) =  PR + C + +  = PR + + − HJ + +
 Q 2Q 2Q  Q 2 2Q 2Q
 
◼ Finding the optimal values: TC (Q, J )

=0 and TC (Q, J )
=0
J Q
TC (Q, J ) HJ KJ TC (Q, J ) CR H HJ 2 KJ 2
= −H + + =0 =− 2 + − − =0
J Q Q Q Q 2 2Q 2
2Q 2
2CR ( H + K ) J 2
(Q ) = +
* * 2
HQ
J* = H H
H +K
2CR H (Q* ) 2
(Q ) =
* 2
+
H H +K
HKQ* 2CR H + K
TC (Q , J ) = PR +
* *
= PR + KJ * Q* =
H +K H K

Deterministic
◼ Example 6 : The PUPE Manufacturing Company purchases 8000 units of a product each year
at a unit cost of $10.00. The order cost is $30.00 per order, and the holding cost per unit per
year is $3.00. What are the economic order quantity, the total annual cost, the number of order
to place in one year, and the reorder point when the lead time is two weeks? (Additional Data :
Let the stock out cost per unit per year is $1.00)
2(30)(8000) 3+1
𝑄∗ = = 800 units
3 1
3(800)
𝐽∗ = = 600 units
3+1
𝑅𝐿 8000 2
𝐵= − 𝐽∗ = − 600 = −292 units
𝑁 52
𝑇𝐶 𝑄∗ , 𝐽∗ = 10 8000 + 1 600 = $80,600
𝐽∗ 600
Longest Delay = = = 0.075 years or 3.9 week
𝑅 8000

Economic Production Quantity (EPQ) Model
Deterministic
◼ Similar to the EOQ model expect that delivery is not spontaneous. That
is there is a production rate involved.
Q
I max
 −R
B
 −R
tπ L T

Deterministic
Cost per cycle without demand rate: 1

PQ + C + HQT
2
Cost per cycle with demand rate:
1
where PQ + C + HI max T
2
I max = t ( − R)
Q
= ( − R)

R
= Q(1 − )

= Q(1 −  )
Hence = PQ + C +
1
HQ(1 −  )T
2

Deterministic
1  1 Q R 1
TC (Q) =  PQ + C + HQ (1 −  ) TC (Q) = PR + C + HQ(1 −  )
T  2 R  Q 2
dTC(Q) R 1
= −C 2 + H (1 −  ) = 0
dQ Q 2
2CR
Q* =
H (1 −  )
𝑇 𝑄∗ = 𝑃𝑅 + 𝐻𝑄∗ (1 − 𝜌)

Deterministic
Example 7 : the demand for an item is 20,000 units per year, and there are 250 working days per year.
production rate is 100 units per day, and lead time is 4 days. The unit production cost is $50.00, the holding
cost is $10.00 per unit per year, and the setup cost is $20.00 per run. What are the economic production
quantity, the number of runs per year, the reorder point, and the minimum total annual cost?
2CR 2(20)(20,000)
Q* = = = 632
H (1 −  ) 10(1 − 20,000 / 25,000)
ROP = RL = 20,000(4 / 250) = 320 units

R 20,000
m= *
= = 31.6 runs/year
Q 632
TC (Q* ) = PR + 2CRH (1 −  )
= 50(20,000) + 2(20)(20,000)(10)(1 − 20,000 / 25,000)

= $1,001,264
Economic Order Interval (EOI) Model
Deterministic
The fixed order interval system, also called a periodic inventory system, is based on a periodic rather than a
continuous review of the inventory stock position.
Inventory level
Time
L L L T L
T T
Total annual cost = purchase cost + order cost + holding cost
1
TC (T ) = PR + mC +
PfR C PfRT
= PR + + where m= = number of orders or reviews per years,
T
2m T 2
R RT
= = average inventory in units,
2m 2
1
T = = order interval in years.
Asst. Prof. Anot Chaimanee, D.Eng. m
77
Deterministic
Total cost per year 𝑇𝐶 ∗ (𝑇)
Total cost
𝑃𝑓𝑅𝑇
2
Cost →
𝑃𝑅
𝐶
𝑇
0 T* Order Interval →
dTC (T ) C PfR 2C 1 PfR
=− 2 + =0 T* = m* = =
dT T 2 PfR T* 2C

Deterministic
The order quantity for the fixed order interval is simply Q = RT
2C 2CR 2CR
Q* = RT * = R = =
PfR Pf H
The maximum inventory level E must be large enough to satisfy demand during
order interval T and also during the lead time L
E = RT + RL = R (T + L) = Q + B
Replace T by T* in the total annual cost equation
TC (T * ) = PR + HRT *

Deterministic
Example 8 : The manufacturing company purchases 8,000 units of a product each year at a unit cost is
$10.00. The order cost is $30.00 per order, and the holding cost per unit per year is $3.00. What are the
economic order interval, the maximum inventory level, and the total annual cost when the lead time is
10 days and there are 250 operating days in the year
2C 2(30)
T* = = = 0.05 years = 12.5 days
HR 3(8000)
R(T + L) 8000(12.5 + 10)

E= = = 720 units
N 250
TC (T * ) = PR + HRT * = 10(8000) + 3(8000)(0.05) = $81,200
Note that the optimum total annual cost is exactly the same for the fixed order interval system as for
the fixed order size system. (See example 2)
Reference
◼ Tersine, R.J. (1994).Principle of Inventory and
Materials Management, Fourth Edition. PTR
Prentice Hall, Englewood Cliffs, New Jersey,
USA.
◼ Supithak, W. Handout of Inventory Theory
Subject, Department of Industrial Engineering,
Kasetsart University, Thailand.
◼ Supithak, W. (2022) Inventory Planning (Theory
and Simulation), Chulalongkorn University
Press, Bangkok, Thailand.
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Inventory and Materials

Anot Chaimanee, D.Eng. 1

Independent Demand Systems Independent Demand Systems

Lot-For-Lot Ordering Economic Order Quantity (EOQ) EOQ

◼ Demand occurs at discrete equal intervals

Anot Chaimanee, D.Eng. 5

◼ Let R1, R2,…, RN denote the demand in periods 1, 2, …, N. The problem is to

◼ First find Q for the EOQ using average demand.

◼ Find Q* by comparing total demand for a number of periods with

Anot Chaimanee, D.Eng. 11

◼ The replenishment quantity Q associated with a particular value of T is

Anot Chaimanee, D.Eng. 14

𝑇𝑅𝐶(𝑇) 𝐶 + 𝑃ℎ σ𝑇𝑘=1(𝑘 − 1)𝑅𝑘

◼ The replenishment quantity is

Anot Chaimanee, D.Eng. 16

Anot Chaimanee, D.Eng. 18

Pj = P =$20/unit, Cj= C = $54, hj= h = $0.40/unit/month, C/h = 135

Anot Chaimanee, D.Eng. 19

◼ Items with a limited useful life because of supply and demand

Anot Chaimanee, D.Eng. 20

Anot Chaimanee, D.Eng. 21

◼ Perfect planning is possible

Anot Chaimanee, D.Eng. 22

◼ Use lead time that fits goal

Anot Chaimanee, D.Eng. 23

◼ Assume demand (M) is a random variable with known

Anot Chaimanee, D.Eng. 26

Anot Chaimanee, D.Eng. 27

Anot Chaimanee, D.Eng. 29

Anot Chaimanee, D.Eng. 30

Anot Chaimanee, D.Eng. 31

Anot Chaimanee, D.Eng. 33

INVENTORY STATUS RECORDS PRODUCT STRUCTURE RECORDS

MATERIAL REQUIREMENT PLANNING (MRP)

Planned Order Release

Purchase orders (PO) Work orders (WO) Reschedule notices (RN)

Anot Chaimanee, D.Eng. 35

Lot Lead On Safety Allo- Level Period

Anot Chaimanee, D.Eng. 36

B(1) C(2) C(1) E(1)

D(1) E(2) D(1) E(2)

Anot Chaimanee, D.Eng. 37

Anot Chaimanee, D.Eng. 38

Anot Chaimanee, D.Eng. 39

Anot Chaimanee, D.Eng. 40

Asst. Prof. Anot Chaimanee, D.Eng. 41

Time Standard 1 year 4 quarters 12 months 52 weeks

Asst. Prof. Anot Chaimanee, D.Eng. 45

◼ To determine an optimal inventory policy, information on each of the

Asst. Prof. Anot Chaimanee, D.Eng. 49

Asst. Prof. Anot Chaimanee, D.Eng. 50

◼ An external shortage occurs when a customer’s order

Asst. Prof. Anot Chaimanee, D.Eng. 51

Asst. Prof. Anot Chaimanee, D.Eng. 52

Asst. Prof. Anot Chaimanee, D.Eng. 54

Total annual cost = purchase cost + order cost + holding cost

Asst. Prof. Anot Chaimanee, D.Eng. 55

Optimum level Inventory level

Asst. Prof. Anot Chaimanee, D.Eng. 56

Cycle Inventory = Q * / 2 = 490 computers

Average Flow Time = Q * / 2 R = 490 /12,000 = 0.041 years = 0.49 months

Reorder Interval = T = 0.98 months