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Backorder Inventory Model

This document describes two inventory models: a backorder model and a quantity discount model. The backorder model allows for stock outs and assumes demand will not be lost due to stock outs, with backorders fulfilled when the next order arrives. It calculates total annual cost considering setup, holding, and backordering costs to determine optimal order and backorder quantities. The quantity discount model considers that item price decreases with larger order quantities due to discounts. It outlines a typical discount schedule and calculates total cost considering setup, holding, and product costs. It then describes a four step process to determine the discount alternative with the minimum total cost, selecting the optimal order quantity.

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Jatinder Gill
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10K views5 pages

Backorder Inventory Model

This document describes two inventory models: a backorder model and a quantity discount model. The backorder model allows for stock outs and assumes demand will not be lost due to stock outs, with backorders fulfilled when the next order arrives. It calculates total annual cost considering setup, holding, and backordering costs to determine optimal order and backorder quantities. The quantity discount model considers that item price decreases with larger order quantities due to discounts. It outlines a typical discount schedule and calculates total cost considering setup, holding, and product costs. It then describes a four step process to determine the discount alternative with the minimum total cost, selecting the optimal order quantity.

Uploaded by

Jatinder Gill
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as DOC, PDF, TXT or read online on Scribd
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Backorder Inventory Model

In this model, we assume that stock outs (and


backordering) are allowed.
In addition to previous assumptions, we assume that
sales will not be lost due to a stock out.
Because, we will back order any demand that can
not be fulfilled
B: Backordering cost per unit per year
b: The amount backordered at the time the next
order arrives
Q – b: Remaining units after the backorder is
satisfied

Total Annual Cost = Annual Setup Cost + Annual


Holding Cost + Annual Backordering Cost
 Annual Setup (Ordering) Cost = (D/Q) . S
Annual Holding Cost = (Average Inventory Level) . H
By using the graphical ratios, we know that:

T1 / T = (Q – b) / Q Therefore, if we replace
T1/T in the above equation we get

 Average Inventory Level = (Q – b)2 / 2Q
By using the graphical ratios, we know that:
T2 / T = b / Q Therefore, if we replace T2/T in
the above equation we get
Average Backordering = b2 / 2Q and
We find optimum order quantity (Q*) and optimum
backordering quantity (b*) by taking the derivatives
of dTC/dQ = 0 and dTC / db = 0 and then putting
the values in their places.
Quantity Discount Model
A quantity discount is simply a reduced price (P) for
an item when it is purchased in LARGER quantities.
A typical quantity discount schedule is as follows:
Since the unit cost for the Third discount is the
lowest, We might be tempted to order 2000 or more
units.
However, this quantity might not be the one that
minimizes the Total Cost.
Remember that, As the quantity goes up, the
holding cost increasesHere, there is a trade off
between reduced product price (P) and increased
holding cost (H).
Total Cost = Setup Cost + Holding Cost + Product
Price (Cost)
Total Cost = DS / Q + QH / 2 + PD where P
is the price per unit
To determine the minimum Total Cost, we perform
the following process which includes 4 steps:
Step 1: Assume that
I: is a percentage value, and
I . P represents the holding cost as a percentage of
price per unit (P).
For each discount alternative, calculate a value of
Q* = [2DS / IP]1/2
Here, instead of using a value of H, the holding cost
is equal to I . P
That is, If the item is expensive (such as a Class A
Item), Its holding cost will be higher.
Since the price of item (P) is a factor in Annual
Holding Cost, we can no longer assume that the
holding cost is constant (such as H) when price
changes.
Step 2: For any discount alternative,
If the calculated optimum order quantity (Q*) is too
low to qualify for the discount range,
Then, Adjust the order quantity upward to the
lowest quantity that will qualify for the particular
discount alternative.
Step 3: Using the total cost (TC) equation above,
compute a total cost for every order quantity (Q).
Use the adjusted Q values.
Step 4: Select the discount alternative which has the
minimum Total Cost (TC).

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