Inventory Models

 Inventory is the stock of any item or resource used

in an organization and can include: raw materials,
finished products, component parts, supplies, and
work-in-process
 An inventory system is the set of policies and
controls that monitor levels of inventory and
determines what levels should be maintained,
when stock should be replenished, and how large
orders should be made

Need to determine when and how much

to order
 Basic EOQ Model

Important assumptions:
1. Demand is known, constant, and independent
2. Lead time is known and constant
3. Receipt of inventory is instantaneous and
complete
4. Quantity discounts are not possible
5. Only variable costs are setup and holding
6. Stockouts can be completely avoided
 Inventory Usage Over Time

Usage rate Average

Order quantity inventory on
= Q (maximum hand
inventory
level) Q
2

Minimum
inventory
 Minimizing Costs
Objective is to minimize total costs
Curve for total
cost of holding
and setup

Minimum
total cost
Annual cost

Holding cost
curve

Setup (or order)

cost curve
Optimal Order quantity
order
quantity
 The EOQ Model Annual setup cost = S
D
Q

Q= Number of pieces per order

Q*= Optimal number of pieces per order (EOQ)
D= Annual demand in units for the Inventory item
S= Setup or ordering cost for each order
H= Holding or carrying cost per unit per year

Annual setup cost = (Number of orders placed per year)

x (Setup or order cost per order)

Annual demand Setup or order

=
Number of units in each order cost per order

= D (S)
Q
 D
The EOQ Model Annual setup cost = S
Q
Q
Annual holding cost = H
2

Q= Number of pieces per order

Q*= Optimal number of pieces per order (EOQ)
D= Annual demand in units for the Inventory item
S= Setup or ordering cost for each order
H= Holding or carrying cost per unit per year

Annual holding cost = (Average inventory level)

x (Holding cost per unit per year)

Order quantity
= (Holding cost per unit per year)
2

= Q (H)
2
 The EOQ Model Annual setup cost = S
D
Q
Q
Annual holding cost = H
2
Q= Number of pieces per order
Q*= Optimal number of pieces per order (EOQ)
D= Annual demand in units for the Inventory item
S= Setup or ordering cost for each order
H= Holding or carrying cost per unit per year
Optimal order quantity is found when annual setup cost equals
annual holding cost

D Q
S = H
Q 2
Solving for Q*
2DS = Q2H
Q2 = 2DS/H
Q* = 2DS/H
 An EOQ Example
Determine optimal number of material to order
D = 1,000 units
S = $10 per order
H = $.50 per unit per year

Q* = 2DS
H
2(1,000)(10)
Q* = 0.50
= 40,000 = 200 units
 An EOQ Example
Determine optimal number of order
D = 1,000 units Q* = 200 units
S = $10 per order
H = $.50 per unit per year
Expected Demand D
number of N= =
orders Order quantity Q*
1,000
N = 200 = 5 orders per year
 An EOQ Example
Determine expected time between orders
D = 1,000 units Q*= 200 units
S = $10 per order N = 5 orders per year
H = $.50 per unit per year

Number of working
Expected time days per year
between orders T=
N
250
T= = 50 days
5
Determine optimal total annual cost
D = 1,000 units, Q* = 200 units
S = $10 per order, N = 5 orders per year
H = $.50 per unit per year, T = 50 days

Total annual cost = Setup cost + Holding cost

D Q
TC  S  H
Q 2
1,000 200
 ($10 )  ($.50 )
200 2
 (5)($10 )  (100 )($.50 )
 $50  $50  $100
 Reorder Points

 EOQ answers the “how much” question

 The reorder point (ROP) tells when to order

Demand Lead time for a new

ROP = per day order in days
=dxL

d= D
Number of working days in a year
 Reorder Point Curve

Q*
Inventory level (units)

Slope = units/day = d

ROP
(units)

Time (days)
Figure 12.5 Lead time = L
 Reorder Point Example

Demand = 8,000 DVDs per year

250 working day year
Lead time for orders is 3 working days

D
d=
Number of working days in a year
= 8,000/250 = 32 units

ROP = d x L
= 32 units per day x 3 days = 96 units