IE_425_H7_Inventory_Theory_I (1).pdf

# IE_425_H7_Inventory_Theory_I (1).pdf - INVENTORY THEORY I...

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1 INVENTORY THEORY I Inventory is material stored, waiting for processing, or experiencing processing. Inventories are ubiquitous throughout all sectors of the economy. Inventories are reported as current assets on the company's balance sheet. Inventories are significant assets that need to be monitored closely. Most managers don't like inventory because it is like money placed in a drawer, assets tied up in investments that are not producing any return and, in fact, incurring a borrowing cost. Inventory also incurs costs for the care of the stored material and is subject to spoilage and obsolescence. In spite of the bad features associated with inventory, it does have positive purposes. Raw material inventory provides a stable source of input required for production. Keeping large inventory levels require less often replenishments and may reduce ordering costs because of economies of scale. In- process inventory reduces the impact of the variability of the production rate in a plant and protects against failures in the processes. Final goods inventory provides for better customer service. The variety and easy availability of the product is an important marketing consideration. Inventory control policies are decision rules that focus on the trade-off between the costs and benefits of alternative solutions to questions of when and how much to order for each different type of item. Now we will discuss several types of inventory cost models to determine optimal policies starting with the deterministic case. Even though many features of an inventory system involve uncertainty of some kind, it is common to assume much simpler deterministic models for which solutions are found using mathematically. Deterministic models also provide a base on which to incorporate assumptions concerning uncertainty. COSTS TO BE CONSIDERED IN AN INVENTORY PROBLEM 1. Cost of ordering or manufacturing : ± ² z c , where z is the amount to order or manufacture. Two important forms: a) Linear: ± ² z c z c , where c is the unit price (cost). b) Two terms: a linear term and a constant term, i.e., c(z) z

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2 ¯ ® ­ ! ³ , 0 z , 0 z , z c K , 0 ) z ( c where K is the setup cost (administrative cost, ordering cost, etc.). 2. Holding cost : This includes the costs associated with storage (opportunity cost, storage space, insurance, protection, taxes, etc.). The cost may be function of: a) Maximum quantity held during a period. b) Average amount held during a period. c) Cumulated excess of supply over demand during a period.
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