A retailer needs to choose the inventory level for the comin

A retailer needs to choose the inventory level for the coming season. The retailer estimates the demand will have a 60% chance to be 30 and 40% chance to be 20.The ordering cost is $4 for each unit. The retail price is $10. For each unit of surplus inventory, the salvage value is $2. The penalty cost for each unit of unmetdemand is $3. There are only two feasible ordering strategy: 25 or 20. Which ordering strategy is more beneficial to the retailer?

Solution

Solution:

Firstly we have to calculate the expected value of demand by factoring in the probability of demands.

Therefore, expected demand = (0.6*30)+(0.4*20) = 26.

Now, let us analyse the cases of ordering strategy:

If Order size is 20, then unmet demand = (26-20) = 6.

Cost Implications:

Ordering cost = (4*20) = $80

Retail price(Inflow) = (20*10) = $200

Cost of unment demand = 6*3 = $18

Therefore, net gain = 200-80-18 = $102

If ordering strategy is 25:

Ordering cost = 25*4 = $100

Cost of unmet demand = 1*3 = $3

Retail price ( Inflow) = 25*10 = $250

Therefore, net gain = 250-100-3 = $147

Inference:

As seen clearly from the analysis above, net gain is more when the ordering strategy is 25. Therefore, the ordering strategy of 25 is more beneficial to the retailer.