Chapter 12 – Study Module

C) 400 The best batch size for this item is 400. The answer to this problem is determined by using the production order quantity equation for annual demand and production rates. Where, D= Annual Demand (1,000 units) S= Setup Cost ($400) H= Holding Cost ($10 per unit) d= demand rate (1,000 units/50 weeks per year = 20 units per week) p= production rate (40 units per week)

B) 93 The correct reorder point is 93. The reorder point reflects the amount of safety stock needed to cover the lead time for an order plus any random variation in demand. In other words, the business must place the order before running out of inventory so that new units arrive before they are needed. This problem presents a situation with demand variance (average daily demand of 25 with a standard deviation of 5) and a constant lead time (3 days). The following formula is used to calculate the reorder point when a specific service level is expected, demand variance exists, and there is a constant lead time: ROP = demand during lead time plus ZσdLT Demand during lead time is calculated by multiplying daily demand (25 marshmallow peeps) by lead time (3 days). 25 x 3 = 75. In this case, we also need to take into account the amount of safety stock necessary to cover any random variance in demand using the equation ZσdLT, where: Z - standard z-score from normal distribution table (in this case z for 98% service level is 2.055) σd = standard deviation of demand rate (in this case standard deviation of demand is 5) LT = standard deviation of lead time (in this case √3 = 1.732) Thus, ZσdLT = 2.055*(1.732*5) = 2.055*8.66 = 17.8, which would be rounded to 18. The necessary safety stock is 18 marshmallow peeps. Remember, ROP = demand during lead time plus ZσdLT ROP = 25(3) + 18 ROP = 75 + 18 ROP = 93

B) The item has a constant purchase price. The economic order quantity model does not require that the item has a constant purchase price. The economic order quantity model requires that: (1) demand is known and constant, (2) lead time is known and constant, (3) the item has a constant ordering cost, (4) quantity discounts are not possible, and (5) inventory is received instantaneously. The economic order quantity model does not require that safety stock is constant.

C) when to place an order and how many of an item to order The two most important inventory-based questions answered by the typical inventory model are when to place an order and how many of an item to order. Typical inventory models focus on determining timing (when to place an order) and quantity (how much to order). Inventory models do not help answer questions related to the cost of the order. Set-up, ordering, and holding costs are included in typical inventory models and, therefore, do not answer questions related to cost. Further, inventory models are not directly related to vendor selection.

A) total inventory based costs Most inventory models attempt to minimize total inventory based costs. Each inventory model is based on different assumptions and fit different circumstances; however, they all focus on trying to reduce the total cost of inventory including holding costs, ordering costs, and set up costs.

A) Safety stock P systems should have higher safety stock than Q systems. P systems, or fixed-period inventory systems, require that inventory is counted at the end of a specific period of time (e.g., monthly, quarterly, etc.). Because inventory is only counted at one specific time, there is an increased likelihood of a stockout. To reduce this likelihood, companies should have higher safety stock. Q systems, on the other hand, are fixed-quantity systems (or continuous review systems) and they primarily rely on established reorder points to ensure against stockouts.

C) to provide a hedge against inflation One use of inventory is to provide a hedge against inflation. Inventory allows organizations to take advantage of quantity discounts that provide a buffer against future price increases and inflation. These advantages occur for any type of inventory (raw materials, work-in-process, finished goods, and maintenance/repair/operating). Inventory management does not deal directly with the production process. Instead, inventory management involves planning, coordinating, and controlling the acquisition, storage, handling, movement, and sale of different types of inventory.

A) 14 is the reorder point, and 100 is the order quantity. The true statement is 14 is the reorder point, and 100 is the order quantity. The reorder point represents the appropriate level to place orders to allow for delivery and setup time without running out of an item. The order quantity represents the total number of items that need to be ordered at each purchase interval. Safety stock represents inventory stock that is held to avoid potential stockouts and is not the same as a reorder point.

C) adding safety stock If demand is not uniform and constant, the stockout risks can be controlled by adding safety stock. Safety stock represents the buffer a company holds to reduce the risk of running out of inventory. Appropriate levels of safety stock balance stockout risks with the increased holding costs. The EOQ model requires the assumption that demand is uniform and constant and, therefore, would not be appropriate in this situation. Placing an extra order does not take into account the variance in demand and, therefore, a stockout risk is still present.

A) Safety stock P systems should have higher safety stock than Q systems. P systems, or fixed-period inventory systems, require that inventory is counted at the end of a specific period of time (e.g., monthly, quarterly, etc.). Because inventory is only counted at one specific time, there is an increased likelihood of a stockout. To reduce this likelihood, companies should have higher safety stock. Q systems, on the other hand, are fixed-quantity systems (or continuous review systems) and they primarily rely on established reorder points to ensure against stockouts.

C) is a process by which inventory records are verified for accuracy Cycle counting is a process by which inventory records are verified for accuracy. Cycle counting requires continuous audits and is used to count inventory and audit records based on the ABC model of inventory management. Class A items are counted regularly (e.g., daily or monthly), Class B items are counted less frequently (e.g., quarterly), and Class C items are counted relatively infrequently (e.g., every 6 months). This system of inventory auditing allows the most valuable items (Class A items) to be counted more frequently and is less disruptive to overall operations. Cycle counting does not require or assume that all inventory records must be verified with the same frequency or that the most frequently used item must be counted more frequently. Instead, by using a cycle counting approach to inventory audits, companies are counting their most valuable inventory (Class A items) frequently and their least valuable inventory (Class B and Class C items) infrequently.

C) increasing stockroom accessibility Inventory record accuracy would be decreased by increasing stockroom accessibility. Stockroom accessibility deals with the number of individuals who can enter, deliver, and remove inventory items. As the number of people with access increases, the accuracy of inventory records will decrease for a number of reasons including inconsistent record keeping, inventory shrinkage, failure to log items appropriately, and failing to store items in the appropriate location. ABC analysis is an inventory management process that improves record accuracy by dividing on-hand inventory into three classes generally based upon annual dollar volume. Increasing reorder points (when businesses place orders) would increase the number of inventory items coming into the business, but should not lead to a decrease in inventory record accuracy.

C) a perpetual inventory system A system that keeps track of each withdrawal or addition to inventory continuously is a perpetual inventory system. Perpetual inventory systems keep inventory records accurate because they require constant tracking of each withdrawal or addition made to inventory continuously. A fixed-period inventory system makes purchases based on specific time periods. A fixed-quantity system is an EOQ based system with the same order amount each time.

B) Safety stock inventory Safety stock inventory is not one of the four main categories of inventory. The four main categories of inventory include raw material inventory, work-in-process inventory, maintenance/repair/operating inventory and finished goods inventory. Raw material, work-in-process, and finished goods inventory represent what the organization will sell to customers.

B) a stockout is possible. A disadvantage of the fixed-period inventory system is that a stockout is possible. Using a fixed-period inventory system increases the likelihood of a stockout because there is no routine count of inventory during a specific review period. Instead of basing inventory orders on the amount of stock on hand (or predetermined reorder points), inventory orders are made at the end of a specified time interval. Fixed-period systems do not necessarily involve higher ordering costs than fixed-quantity inventory systems. Fixed-period inventory systems do not create the need for additional inventory records or lower average inventory level. While this approach does increase the likelihood of a stockout, it is appropriate for perpetual inventory systems where counting inventory is routine.

B) annual dollar value ABC analysis divides on-hand inventory into three classes generally based upon annual dollar volume, which is calculated by multiplying unit price by annual demand. ABC inventory analysis is based on the principle that a small percentage of items typically consume a larger portion of dollar volume. Class A items account for a large dollar value (approximately 70-80% of dollar usage), but a smaller part of inventory (approximately 15%). Class B items account 15-25% of total dollar usage and approximately 30% of total inventory. Class C items account for approximately 5% of total dollar usage and about 55% of inventory items. This approach to inventory management allows firms to focus on the few critical parts that drive dollar volume and not the many trivial ones.

A) is appropriate when units are produced and sold simultaneously The production order quantity model is appropriate when units are produced and sold simultaneously. The production order quantity model requires the assumption of a known, constant demand and a known, constant lead time. Like the EOQ model, the production order quantity model includes holding costs (which represent the costs of storing inventory over time) in the formula. As a result, both the production order quantity model and the EOQ try to balance inventory costs with stockout risks. The EOQ model requires instantaneous delivery not the production order quantity model.

C) increase the cost of the inventory policy In the probabilistic model, increasing the service level will increase the cost of the inventory policy. Probabilistic models are applicable when product demand (or other variables) are not known, but can be estimated by using probability distributions. Because these models rely on estimates, organizations must develop inventory policies that rely on an increased safety stock to buffer against inaccurate estimates.

B) total inventory based costs Most inventory models attempt to minimize total inventory based costs. Each inventory model is based on different assumptions and fit different circumstances; however, they all focus on trying to reduce the total cost of inventory including holding costs, ordering costs, and set up costs.

C) 200 The EOQ is 200. Using the basic EOQ formula: Q= the square root of (2xDxS/H) Q* = Economic Order Quantity D = Annual Demand (in this case 2,000 units) S = Fixed cost per order (in this case $75) H = Holding or Carrying cost (7.50 per unit) Step 1: Calculate 2*D (Annual Demand)*S(Cost per Order) 2*2,000*75 = 300,000 Step 2: Divide 2*D (Annual Demand)*S(Cost per Order)/H 300,000/7.50 = 40,000 Step 3: Take square root of 40,000 Square root of 40,000 = 200

A) 41 The safety stock required to provide a 95% service level is 41. The necessary level of safety stock for a given service level is calculated by using the following formula: ZσdLT Where: Z - standard z-score from normal distribution table (in this case z for 95% service level is 1.65) σdLT = standard deviation of demand during lead time (in this case standard deviation of demand is 25) 1.65*25 = 41.25, which would be rounded to 41.

C) the production order quantity model does not require the assumption of instantaneous delivery The difference between the basic Economic Order Quantity (EOQ) model and the production order quantity model is that the production order quantity model does not require the assumption of instantaneous delivery. The production order quantity model applies to producing situations. When producing goods, managers must allow for the time it takes to build or assemble the goods. In this case, the arrival of goods is not instantaneous. As with the EOQ model, the production order quantity model does require the assumption of a known, constant demand and a known, constant lead time.

B) when to place an order and how many of an item to order The two most important inventory-based questions answered by the typical inventory model are when to place an order and how many of an item to order. Typical inventory models focus on determining timing (when to place an order) and quantity (how much to order). Inventory models do not help answer questions related to the cost of the order. Set-up, ordering, and holding costs are included in typical inventory models and, therefore, do not answer questions related to cost. Further, inventory models are not directly related to vendor selection.

C) choosing the level of safety stock that assures a given service level The appropriate level of safety stock is typically determined by choosing the level of safety stock that assures a given service level. Safety stock represents extra inventory that a company holds to protect itself against uncertainties in either demand or replenishment time. Safety stock increases holding costs for companies; therefore, most organizations aim to hit a specific service level (such as 95%) in their safety stock calculation. A 95% service level could result in stockouts, but it is at a level that is satisfactory to the company. The lower the service level (e.g., 80% vs. 95%), the lower the requirement for safety stock. The higher the service level, the higher the holding costs and increased risk of waste for time-sensitive goods such as food and drinks.

B) the production order quantity model does not require the assumption of instantaneous delivery

A) more in supplier development for A items Policies based on ABC analysis might include investing more in supplier development for A items. Using ABC analysis allows companies to prioritize their inventory by the annual dollar volume. Class A items will get the most attention including supplier development, records verification, and forecasting. Class B will receive less attention and Class C items will receive the least amount of time and attention.

B) to minimize the sum of setup cost and holding cost The primary purpose of the basic economic order quantity model is to minimize the sum of the setup and holding cost. The basic goals of the economic order quantity model are to minimize the total costs of ordering, setup, and holding and to compute the appropriate quantity to order. While organizations are interested in determining the appropriate reorder point and the most effective service level, these issues are not directly related to the economic order quantity model.

B) a fixed-period system A system that triggers ordering on a uniform time basis is called a fixed-period system. A fixed-period inventory system makes purchases based on uniform and specific time periods (e.g., monthly, quarterly, etc.). The reorder point represents the appropriate level to place orders to allow for delivery and setup time without running out of an item. A fixed-quantity system is an EOQ based system that specifies the same order amount each time. The goal of all economic order quantity models is to minimize the total costs of ordering, setup, and holding costs by calculating the most efficient order quantity.

A) safety stock Extra units that are held in inventory to reduce stockouts are called safety stock. Safety stock represents inventory held at any point (raw materials, work-in-process, or finished goods) to prevent stockouts due to unpredictable spikes in demand, late shipments, long shipment times, or production breakdowns. The reorder point represents when the business needs to place orders to allow for delivery and setup time without running out of an item. Just-in-time inventory represents an inventory management concept, but does not deal with a specific number of items held in stock.