David Rivera Optical has a reorder point of 50 frames. The annual carrying cost is 5 dollars per frame, and the stockout cost is 40 dollars per frame. The firm places 6 orders per year. If there is a 20 percent probability of demand being 60 frames during lead time (a shortage of 10), and a 10 percent probability of demand being 70 (a shortage of 20), what is the stockout cost for a policy of zero safety stock?
Explanation
When demand is probabilistic, a firm can calculate the expected annual stockout cost for a given reorder policy. This is done by summing the costs for each possible shortage scenario, where each scenario's cost is (units short * probability of that shortage * cost per stockout * number of orders per year).
Other questions
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