Question

The Eat Meats West restaurant stocks a Margaret River table wine it purchases from a wine merchant in Perth. The annual demand for the wine is 1000 bottles. It costs the restaurant $25.50 each time it places an order. The holding cost is $8 per bottle per year. The daily demand for the wine is normally distributed with a mean of 12.5 bottles and a standard deviation of 5 bottles. The lead time to receive an order is 1 day.

(a) What is the recommended order quantity?

(b) The restaurant manager has requested an order size that will enable him to limit the probability of a stockout to 2%. What is the reorder point and the safety stock level?

Answer 1

(a) Economic Order Quantity = EOQ = √(2C_oD/C_c)

Where, C_o is the cost of placing one order = $25.50

D - annual demand = 1000

C_c - annual per-unit holding cost = $8

EOQ = √(2*25.50*1000/8) = 79.84

(b)

Safety Stock = zσ_d√L

Where z = number of standard deviations based on service level 98% = 2.054 from z table

σ_d = standard deviation of daily demand = 5

L = Lead Time = 1 day

Safety Stock = 2.054*5*√1 = 10.27

Reorder point = dL + zσ_d√L

where d = average daily demand = 12.5

Reorder Point = 12.5*1 + 2.054*5*√1 = 22.77