Scott’s Vacuum Cleaner Manufacturing Company produces 24,000 vacuum cleaners per year. One component part is required that is currently manufactured at one of its own facilities. It costs the company $10 per component, plus $20 to initiate a production order. They estimate that they have capacity to produce up to 40,000 components per year. Assume that holding costs are based on 24% annual interest.
Suppose that a supplier has offered to supply the items at the same costs ($10/component with a $20 order cost). Suppose that an EOQ model will be used to resupply the item.
Suppose that the supplier has been chosen to supply the items at a cost of $10/component, but that demand is random with a standard deviation of 500/month. Assume leadtime for orders is one month, and the manufacturer charges the supplier a penalty of $2/component/month for each shortage.
If the manufacturer decides to order every month, explain the policy that should be used to maintain a 95% Type I service level, including order size, reorder point, etc.