Chapter 7 Inventory Management

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1 Chapter 7 Inventory Management TRUE/FALSE 1. The four broad categories of inventories are raw materials, work-in-process, subassemblies, and finished goods. F 2. The ABC inventory control system categorizes inventory items into three groups, A, B, and C. A items are given highest priority, while C items have the lowest priority. Prioritization may be based on annual dollar usage, shelf life, or sales volume. 3. The EOQ, also known as the economic order quantity, is the optimal order size in terms of cost because it minimizes the annual total inventory cost. The EOQ is the lot size where inventory holding costs equal annual ordering costs. 4. The total annual inventory cost is the sum of the annual purchase cost, the annual holding cost, the annual capacity cost, and the annual ordering cost. F 5. Service parts sold to the repair shops are examples of dependent demand. F 6. Inventory turnover ratio shows how many times a firm turns over its inventory in an accounting period. Faster turnovers are generally viewed as negative because it indicates instability in the firm's inventory level. F 7. The ABC inventory matrix shows an ABC inventory classification based on annual usage on the vertical axis and an ABC inventory classification based on physical inventory on the horizontal axis. 8. The ABC inventory matrix is used to monitor whether the firm is stocking the correct type of inventory and to detect obsolete stock. 9. Radio Frequency Identification (RFID) is considered an eventual replacement of bar code because of its ability to store huge amount of information to differentiate specific unit of good.

2 10. Electronic Product Code (EPC) is the only RFID standard adopted by the commercial sector and the U.S. Department of Defense. F 11. An RFID reader does not require direct line of sight to read the information stored in an RFID tag. 12. Relaxing the constant price assumption of the classic EOQ model results in the Quantity Discount model. 13. Relaxing the instantaneous replenishment assumption of the EOQ model results in the Economic Manufacturing Quantity model. 14. The optimal order quantity for the quantity discount model may exist at a price breakpoint. 15. In the Economic Manufacturing Quantity model, the annual consumption rate must be higher than the annual production rate. F 16. In the Economic Manufacturing Quantity model, average inventory is one-half of the economic manufacturing quantity. F 17. When demand and lead time are constant, reorder point is the demand during lead time. 18. The continuous review inventory system is more expensive to monitor compared to the periodic review inventory system. 19. The (s, S) continuous review inventory system orders the same quantity Q when physical inventory reaches the reorder points. F 20. The periodic inventory review system reviews physical inventory at specific points in time. 21. Cycle counting counts the physical inventory to ensure that physical inventory matches against records.

3 MULTIPLE CHOICE 1. Which of the following is NOT an assumption of the classic Economic Order Quantity (EOQ)? a. Lead time is known and constant. b. Demand is known and constant. c. Instantaneous replenishment. d. There is no quantity discount. e. The production rate must be greater than the consumption rate. E 2. If an item is ordered at its economic order quantity, the annual carrying cost should be: a. slightly less than the annual ordering cost. b. equal to the annual ordering cost. c. twice the annual purchase price. d. the square root of the annual ordering cost. e. cannot be determined because there is insufficient information provided. B 3. What inventory factor may be omitted from the basic EOQ derivation because it is a constant? a. Annual order-processing cost b. Annual purchase cost of goods c. Annual capital cost d. Annual setup costs e. all of these B 4. If usage is constant, as order size increases, annual order costs but annual carrying costs. a. increase... increase b. decrease... decrease c. increase... decrease d. decrease... increase e. remain the same... increase D 5. Which one of the following statements regarding the economic order quantity is true? a. The EOQ model combines several different item orders to the same supplier. b. If an order quantity is larger than the EOQ, the annual holding cost exceeds the annual ordering cost. c. The EOQ model assumes a variable demand pattern. d. When the interest rate drops, both the holding cost and the EOQ decreases. e. EOQ is used to determine the optimum shipping quantity. B 6. The cost of a widget is $5, and the carrying rate is 40%; cost of processing an order is $25, annual demand is for 400 widgets, and supply and usage patterns are stable. What is the economic order quantity (EOQ)? a. 5 b. 20

4 c. 25 d. 100 e. 200 D 7. The cost of a widget is $5, and the carrying rate is 40%; the cost of processing an order is $25, the annual demand is 400 widgets, and supply and usage patterns are stable. Assuming you are ordering at the lot size of 200 units per order (not the EOQ quantity). What is the annual ordering cost? a. $10 b. $25 c. $50 d. $200 e. Cannot be determined based on the given information. C 8. Companies hold a supply of inventory for all of the following reasons EXCEPT: a. meet variation in product demand b. increase production change/setup costs c. allow production scheduling flexibility d. purchase in bulk to take advantage of quantity discounts e. maintain independence of operations (Decoupling) B 9. Which of the following cannot be considered as independent demand items? a. wholesale and retail merchandise items b. maintenance, repair, and operating supplies at a manufacturing company c. maintenance, repair, and operating supplies at a service firm d. raw material items that become part of the final product at a manufacturing firm e. service industry items such as hospital supplies or office supplies for law firms D 10. Which of the following is not an example of an ordering cost for products purchased from a supplier? a. the cost of transmitting the order b. the cost of receiving the product c. the cost associated with processing the invoice d. the opportunity cost of not ordering from a least cost supplier e. the cost of handling the product D 11. In the absence of demand and delivery lead time variation, if demand is eight per day and purchase lead time is four days, the reorder point is: a. 3. b. 8. c. 32. d. 35. e. 56. C 12. In the absence of demand and delivery lead time uncertainty, reorder point is the. a. demand during lead time

5 b. safety stock c. sum of demand during lead time and safety stock d. economic order quantity e. average inventory A 13. In the presence of demand and delivery lead time uncertainty, reorder point is the. a. demand during lead time b. safety stock c. sum of demand during lead time and safety stock d. economic order quantity e. average inventory C 14. Which of the following is a disadvantage of excessive inventory? a. It hides production and other problems. b. It leads to higher inventory ordering cost. c. It leads to lower average inventory. d. It eliminates cycle stock. e. It reduces the need to conduct cycle count. A 15. The EOQ model with quantity discounts attempts to determine a. what is the lowest purchasing price. b. whether to use fixed-quantity or fixed period order policy. c. how many units should be ordered. d. what is the shortest lead time. e. what is the lowest amount of inventory necessary to satisfy a certain service level. C 16., such as lubricants for machine, are used in the production process, but do not become parts of the final products. a. Raw materials b. Work-in-process c. Maintenance, repair and operating supplies d. Finished goods e. Cycle stock C 17. Which of the following is not an assumption of the economic order quantity model? a. Demand is known, constant, and independent. b. Lead time is known and constant. c. Quantity discounts are not possible. d. Production and use can occur simultaneously. e. The only variable costs are setup cost and holding (or carrying) cost. D 18. The primary purpose of the basic economic order quantity model is a. to calculate the reorder point, so that replenishments take place at the proper time b. to minimize the sum of carrying cost and holding cost

6 c. to maximize the customer service level d. to minimize the sum of setup cost and holding cost e. to calculate the optimum safety stock D 19. Dependent demand and independent demand items differ in that I. for any product, all components are dependent-demand items II. the need for independent-demand items is forecast III. the need for dependent-demand items is calculated a. I only b. I & II only c. I & III only d. II & III only e. I, II & III E 20. If the actual order quantity is the economic order quantity in a problem that meets the assumptions of the model, the average amount of inventory on hand a. is zero b. is affected by the amount of product cost c. is one-half of the economic order quantity d. is smaller than the holding cost per unit e. cannot be determined from the given information C 21. In the quantity discount model, the optimum order quantity that minimizes annual total costs may exist at: I. the economic order quantity II. the economic manufacturing quantity III. a price break point IV. the average inventory V. the reorder point a. I only b. II only c. III only d. I and III only e. II and III only D 22. Which of the following would most likely be considered a dependent demand item? a. Bicycle tires used to assemble a bicycle b. Television (TV) c. Couch d. Lawn Mower A Figure 7-1 Use the graph below to answer the next question.

7 23. Which of the following is TRUE in relation to Figure 7-1? a. Curve J represents the annual ordering cost, and curve K represents the annual holding cost. b. A lot size of G has an annual total cost of about C. c. At lot size H both holding costs and ordering costs exceed the annual total cost. d. The EOQ is most likely lot size G, and curve L is the annual ordering cost curve. D 24. Use this information below to calculate the optimal order quantity: Annual demand for backpacks is 43,000 units The cost to place an order is $220 The per unit cost of the item is $60.00 The annual holding rate is 37.5% Choose the closest answer. a. 920 units b. 250 units c. 710 units d. 830 units A 25. If your company had an annual purchase cost of items equal to $2,000,000, an annual holding cost of $150,000 and an annual ordering cost of $750,000 this scenario would reveal that: a. Your fixed lot size was lower than the EOQ b. Your fixed lot size was equal to the EOQ c. Your fixed lot size was higher than the EOQ d. Nothing because there is insufficient information to discern where the EOQ would be. A ABC Inventory Matrix Use the graph below to answer the next question(s).

8 26. In the ABC Inventory Matrix, inventory in area X suggests a. under-stocked A and B items. b. under-stocked B and C items. c. overstocked A and B items. d. over-stocked B and C items. e. inventory matches sales. A 27. In the ABC Inventory Matrix, inventory in area Y suggests a. under-stocked A and B items. b. under-stocked B and C items. c. overstocked A and B items. d. over-stocked B and C items. e. inventory matches sales. E 28. In the ABC Inventory Matrix, inventory in area Z suggests a. under-stocked A and B items. b. under-stocked B and C items. c. overstocked A and B items. d. over-stocked B and C items. e. inventory matches sales. D 29. Which of the following is not a major advantage of RFID over bar code technology? a. Ability to store huge amount of information on the RFID tag. b. Cost of the RFID tag. c. Ability to identify goods at the item level. d. Direct line of sight is not needed for the RFID reader to read an RFID tag. B 30. The revenue for a firm is $1,500,000. Its cost of revenue is $800,000 and its average inventory for the year is $50,000. What is the inventory turnover? a times

9 b times c. 16 times d. 30 times C 31. Adagio Store stocks a part that has a normal distribution demand pattern during the reorder period. Its average demand during lead time is 600 units and the standard deviation of demand during lead time is 60 units. What is the statistical reorder point that result in 5 percent stockouts (Z = 1.65)? a. 99 units b. 600 units c. 699 units d. 990 units e units C 32. The UNLV Bookstore sells a unique calculator to college students. The demand for this calculator has a normal distribution with an average daily demand of 20 units and a standard deviation of 4 units per day. The lead time for this calculator is very stable at 9 days. Compute the statistical reorder point that results in a 95 percent in-stock probability (Z = 1.65). a units b. 80 units c. 180 units d units e. 720 units D SHORT ANSWER 1. Briefly describe the differences between dependent and independent demand. Provide examples of dependent and independent demand items for each of the following industries: automotive industry, personal computer industry, bicycle industry Dependent demand items are those parts whose demand is based on the demand of the final product in which the parts are used. Independent demand items are the end items consumers typically buy, and whose demand is affected by trends, seasonal patterns, and general market conditions. Service parts are also considered independent demand items. 1. Automotive Industry: a. Independent demand item car/truck and service parts. b. Dependent demand item tires, axle, steering wheel, and battery used to assemble the automobiles. 2. Personal Computer Industry: a. Independent demand item computer/laptop computer and hardware sold directly to the consumers. b. Dependent demand item monitor, CPU, and keyboard used to assemble the PC. 3. Bicycle Industry: a. Independent demand item bicycle

10 b. Dependent demand item tires, handlebars, chain, and seats used to assemble the bicycles. 2. List four assumptions of the EOQ model. 1. Demand must be known and constant 2. Delivery time must be known and constant 3. Replenishment is instantaneous 4. Price is constant/quantity discounts are not allowed 5. Holding cost is known and constant 6. Ordering cost is known and constant 7. Stockouts are not allowed 3. Name and briefly describe the four basic types of inventory. 1. Raw materials unprocessed, purchased inventory. 2. Work-in-process partially processed inventory. 3. Finished goods inventory or materials that have been completely processed or assembled, ready for sales or shipping to customers. 4. Maintenance, repairs and operating (MRO) supplies (e.g., lubrication) goods used in the manufacturing process, but do not become parts of the finished goods. 4. Describe how an ABC analysis can be used to manage inventory. ABC inventory analysis prioritizes inventory items into A, B and C groups. A inventories are the highest priority and should be managed closely. C inventories are the lowest priority items and most numerous. It is also known as 80/20 rule or Pareto's rule. 5. What is the primary purpose of an ABC inventory matrix? The primary purpose of ABC inventory matrix is to determine whether a company is stocking the correct inventory, and to identify if there is excessive obsolete stock.

11 6. Why is the total purchase price not a factor affecting the order quantity in the classic economic order quantity model? Since there is no quantity discount, the purchase cost is constant regardless of the order quantity. 7. What is the impact on total inventory cost if a firm decides to use an order quantity slightly smaller than the economic order quantity? The economic order quantity model is quite insensitive to slight variation in the order quantity. Using an order quantity that is smaller than the economic order quantity will result in a slightly higher total ordering cost but a slightly smaller carrying cost. The net effect is a slightly higher total inventory costs. 8. Name the two major RFID standards. 1. The Electronic Product Code (EPC) standard managed by the EPCglobal, Inc. 2. The standard of the International Organization for Standardization (ISO). ESSAY 1. Describe the ABC inventory matrix, and how is it used to manage inventory. An ABC inventory matrix is used to assist in identifying obsolete stocks and to analyze whether a company is stocking the correct inventory by comparing two ABC analyses. The vertical axis of the ABC inventory matrix shows the firm's inventory classification based on inventory usage whereas the horizontal axis shows the firm's inventory classification based on physical inventory. Items appearing along the diagonal of the matrix suggest inventory matches sales. Items in the top left triangle indicate under-stocked A and B items, where as items in the lower right triangle suggest overstocked B and C items, or obsolete stocks. 2. What is Radio Frequency Identification (RFID)? Provide four examples or scenarios of how RFID can be used to aid in supply chain management. RFID aids in inventory management by making it easier to track inventory in the supply chain. It can synchronize information and physical flow of goods across the supply chain from manufacturers to retail outlets and to the consumers. Moreover, it is also very useful for tracking returned goods through the supply chain and to prevent counterfeit. For examples,

12 1. Materials management: As supply vehicle enters the warehouse, the fixed-portal RFID reader positioned at the entrance reads the tags on the pallets or individual items to provide handling, routing, and storage information of the incoming goods, and inventory status can be updated automatically. 2. Manufacturing: An RFID tag can be placed on the unit being produced so that specific customer configurations can be incorporated automatically during the production process. This is invaluable in a make-to-order environment. 3. Distribution center: As the logistics vehicle arrives at the loading dock, the fixed-portal RFID reader communicates with the tag on the vehicle to confirm that it is approved to pickup goods. When the loaded vehicle leaves the dock and crosses the portal, the reader picks up the signals from the tags to alert the RFID software and ERP system to update the inventory automatically and initiate an advanced shipping notice (ASN), proof of pickup, and invoices. 4. Retail store: As delivery vehicle enters the unloading dock, the fixed-portal reader picks up the signals from the tags, and the RFID software application processes the signals to provide specific handling instructions and initiates automatic routing of the goods. RFID reader can also be placed on the store shelf to trigger automatic replenishments when an item reaches its reorder point. Moreover, inventory status can be updated automatically in real time at any stage of the supply chain, and handheld readers can be used to assist in cycle counting.

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