One of the first items the company reviewed was the cost of preparing and proces

Question

One of the first items the company reviewed was the cost of preparing and processing a requisition, preparing a purchase order, and making necessary record changes. This was estimated to be $50 per order.

One of the typical items of inventory analyzed in detail was a small hydraulic fitting. Central sells about 21,840 of these fittings per year (each fitting is purchased for $14 and is sold for $19). The manufacturer from whom Central buys the fitting does not offer any quantity discount. The manufacturer is located about 1,500 miles away and the fittings are shipped to Central by truck. They all arrive at once.

The annual per unit inventory holding cost is 20% of the item’s value.

D) Suppose the supplier has a 4 day lead time and that the standard deviation of daily demand is 15 units. What is the necessary reorder point to achieve a 96% service level?

Explanation / Answer

We calculate the Reorder Point by the formula-

ROP = (D * LT) + Safety stock

And to calculate safety stock we use the formula

Safety stock = Z * S.D * D

Where,

D= demand average

S.D= standard deviation

LT= Lead time

Z= service factor at given service level

At 96% service level, Z= 1.75

And it is given that annual demand is 21,840 of the fittings, because that is how much central sells per year. And in a year there is 365 days.

So, D= 21840/365

= 59.84

This on rounding off is 60 units per day

Now, Safety stock = Z * S.D * D

= 1.75 * 15 * 60

= 1575

Now, ROP = (D*LT) + Safety stock

= (60*4) + 1575

= 1815 units

Therefore, the reorder point is 1815 units.

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