RSM 1240

Term 4, 2025

Tutorial Problem Set 5

Textbook Problems: Newsvendor Analysis

Chapter 14: 14.1 (parts d, e, f, and g), 14.5, 14.6, 14.9 (shown as Chapter 12 below).

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Additional Problem

CanadaLoon

CanadaLoon is bringing out a new parka (The Snowmaggedon) for 2020 to be sold through
Canadian specialty stores. These parkas will come in four different colours (Red, Navy, Pink,
and Black). For each colour, they expect to sell to the retailers 2500 units with a standard
deviation of 800 units (normally distributed). The selling price (to the retailers) is $450. The
production cost is $225. Units that are not purchased in Canada will be sold in South America
during July where retailers will only pay $200 per unit.

a) If CanadaLoon needs to produce the units before the retailers order, how many of each
colour should they produce to maximize expected profits?

b) How many parkas does it expect to have left over (from all colours)?

c) What is CanadaLoon’s expected profit?

d) Suppose for each colour the demand will either be zero (no units sold) or the demand will
be normally distributed with a mean of 2500 and standard deviation of 800 units. Each of these
possibilities has a probability of occurring 50% of the time.
How many units of each colour should CanadaLoon produce now?
Hint: Remember that they should produce to cover the critical ratio of demand.

e) How many units will it expect to have left over from each colour?

a)

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Answers: Chapter 14 Problems

14.1 McClure Books

d) The underage cost is Cu = 20 – 12 = 8. The salvage value is 12 – 4 = 8, because Dan can

return left over books for a full refund (12) but incurs a $4 cost of shipping and handling.
Thus, the overage cost is cost minus salvage value: Co = 12 – 8 = 4. The critical ratio is
Cu / (Co + Cu) = 8/12 = 0.6667. In the Standard Normal Distribution Function Table we see
that F(0.43) = 0.6664 and F(0.44) = 0.6700 , so use the round-up rule and choose z = 0.44 .
Now convert z into the order quantity for the actual demand distribution:
Q = µ + z × σ = 200 + 0.44 × 80 = 235.2, rounded up to 236.

e) We want to find a z such that F(z) = 0.95 . In the Standard Normal Distribution Function
Table we see that F(1.64) = 0.9495 and F(1.65) = 0.9505, so use the round-up rule and
choose z = 1.65 . Now convert z into the order quantity for the actual demand distribution:
Q = µ + z × σ = 200 + 1.65 × 80 = 332.

f) If the in-stock probability is 95%, then the stockout probability (which is what we
are looking for) is 1 minus the in-stock, i.e., 1 – 95% = 5%.

g) Evaluate expected lost sales. The z-statistic for 300 units is z = (300 – 200) / 80 = 1.25.
From the Standard Normal Loss Function Table we see that L(1.25) = 0.0506 . Expected
lost sales is σ × L(1.25) = 4.05. Evaluate expected sales, then expected left over inventory
and then expected profit. Expected sales is 200 – 4.05 = 195.95 and Expected left over
inventory is
300 – 195.95 = 104.05. Therefore:

Expected profit = (Price – Cost) × Expected sales

– (Cost – Salvage value) × Expected left over inventory
= (20 – 12) × 195.95 – (12 – 8) × 104.05 = 1151.4

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14.5 Fashionables

a) The underage cost is Cu = 70 – 40 = 30 and the overage cost is Co = 40 – 20 = 20. The

critical ratio is Cu / (Co + Cu ) = 30 / 50 = 0.6. From the Standard Normal Distribution
Function Table, F(0.25) = 0.5987and F(0.26) = 0.6026, so we choose z = 0.26 . Convert
that z-statistic into an order quantity Q = µ + z × σ = 500 + 0.26 × 200 = 552. Note that
the cost of a truckload has no impact on the profit maximizing order quantity.

b) We need to find the z in the Standard Normal Distribution Function Table such that
F(z) = 0.9750 because F(z) is the in-stock probability. We see that F(1.96) = 0.9750 ,
so we choose z = 1.96 . Convert to Q = µ + z × σ = 500 +1.96 × 200 = 892.

c) If 725 units are ordered, then the corresponding z-statistic is

z = (Q – µ)/σ = (725 – 500) / 200 =1.13. We need to evaluate lost sales, expected sales
and expected left over inventory before we can evaluate the expected profit. Expected lost
sales with the Standard Normal is obtained from the Standard Normal Loss Function
Table, L(1.13) = 0.0646 . Expected lost sales is σ × L(z) = 200 × 0.0646 = 12.9.
Expected sales is 500 – 12.9 = 487.1. Expected left over inventory is 725 – 487.1 = 237.9.
Expected profit is

Expected profit = (70 – 40 ) × 487.1 – ( 40 – 20 ) × 237.9

= 9855

So the expected profit per sweater is 9,855. The total expected profit is five times
that amount, minus 2000 times the number of truckloads required.

d) The stockout probability is the probability demand exceeds the order quantity 725, which is
1 – F(1.13) = 12.9% .

e) If we order the expected profit maximizing order quantity for each sweater, then that equals
5 × 552 = 2,760 sweaters. With an order quantity of 552 sweaters expected lost sales is
56.5 = 200 × L(0.26) = 200 × 0.2824, expected sales is 500 – 56.5 = 443.5 and expected
left over inventory is 552 – 443.5 = 108.5. Expected profit per sweater is
Expected profit = (70 – 40 ) × 443.5 – ( 40 – 20 ) × 108.5
= 11,135
Because two truckloads are required, the total profit is then 5 × 11,136 – 2 × 2000 = 51, 675.

If we order only 500 units per sweater type, then we can evaluate the expected profit
per sweater to be 11,010. Total profit is then 5 ×11,010 – 2000 = 53,050. Therefore, we
are better off just ordering one truckload with 500 sweaters of each type.

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14.6 Teddy Bower Parkas

a) The parka sells less than half of the forecast if demand is 2100/2 = 1050 or fewer units.
Normalize the quantity 1050: z = (1050 – 2100)/1200 = –0.88. From the Standard Normal
Distribution Function Table, F(–0.88) = 0.1894, which implies there is a 18.9% probability
that the parka will be a dog.

b) To determine the profit maximizing order quantity, begin with the underage cost, Cu = 22 –
10 =12, and the overage cost, Co =10 – 0 =10. The critical ratio is 12 /(10 +12) = 0.5455. We
see from the Standard Normal Distribution Function Table that F(0.11) = 0.5438 and F(0.12)
= 0.5478, so we choose z = 0.12. Convert that z-statistic back into an order quantity, Q = µ +
z × σ = 2100 + 0.12 ×1200 = 2,244.

c) To hit the target in-stock probability of 98.5%, we need to find the z-statistic such that
F(z) = 0.9850. We see from the Standard Normal Distribution Function Table that
F(2.17) = 0.9850, so we choose z = 2.17 . Convert to Q: Q = 2100 + 2.17 ×1200 = 4704.

d) If 3000 parkas are ordered then the corresponding z-statistic is (3000 – 2100)/1200 = 0.75.
Now look up expected lost sales with the Standard Normal distribution in the Standard Normal
Loss Function Table: L(0.75) = 0.1312 . Convert that lost sales into the expected lost sales with
the actual demand distribution: σ × L(z) = 1200 × 0.1312 = 157.4. Expected sales = expected
demand – expected lost sales = 2100 – 157.4 = 1942.6. Expected left over inventory = 3000 –
1942.6 = 1057.4. Finally,
Expected profit = (22 – 10) × 1942.6 – (10 – 0) ×1057.4
= 12, 737

e) The stock out probability is 1 – F(z) = 1 – F(0.75) = 22.7%

14.9 CPG Bagels

a) We first need to evaluate the overage and underage costs. The underage cost is
Cu = 0.6 – 0.20 = 0.4 , i.e., it is the gross margin on each bagel.

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The overage cost is slightly more complex to evaluate. Assume Day Old bagels are sold for
$0.165 each, but only about 2/3rds of them are sold. Hence, the average salvage value received
on Day Old bagels is $0.165× (2 / 3) = $0.11. The overage cost is then Co = 0.20 – 0.11 = 0.09
because the average loss on each unsold bagel is 9 cents.
The critical ratio is Cu / (Co + Cu) = 0.40 / 0.51 = 0.8163. In the Standard Normal Distribution
Function Table we see that F(0.90) = 0.8159 and F(0.91) = 0.8186 , so we choose z = 0.91.
Convert that z-statistic to a quantity, Q = µ + z ×σ = 54 + 0.91× 21 = 73.11. Hence, the store
should have approximately 73 bagels to maximize its expected profit.
b) If there is an additional $5 cost to a lost sale, then the underage cost is now Cu = 0.4 + 5 = 5.4,
i.e., it is the gross margin plus the additional penalty. The critical ratio is now
Cu /(Co + Cu ) = 5.40 / 5.51 = 0.9836. In the Standard Normal Distribution Function Table we see
that F(2.13) = 0.9834 and F(2.14) = 0.9838 , so we choose z = 2.14 . Convert that z-statistic
to a quantity, Q = µ + z × σ = 54 + 2.14 × 21 = 98.94.
c) If 101 bagels are in stock at 3pm., then the z-statistic is (101– 54) / 21 = 2.24 . Lost sales with
a Standard Normal is (from the Standard Normal Loss Function Table) L(2.24) = 0.0044.
Convert that lost sales into the lost sales for the actual Normal distribution = σ × L(z)
= 21× 0.0044 = 0.0924.
Expected leftover inventory = Q – µ + Expected lost sales = 101 – 54 + 0.0924 = 47.09.

Additional Problems

CanadaLoon

a) If CanadaLoon needs to produce the units before the retailers order, how many of each
colour should they produce to maximize expected profits?

ANSWER:

Cost of Overage = $25

Cost of Underage = $450–$225 = $225
Ratio = 225/250 = 0.9
Z=1.28

Norm.Inv(0.9,2500,800) = 3526 parkas

b) How many parkas does it expect to have left over (from all colours)?

ANSWER:

Expected lost sales for each colour = σ L(z) = 800 x 0.0475 = 38

Expected sales = 2500 – 38 = 2462
Expected leftover = 3525 – 2462 = 1063 for each colour.
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Total = 4 x 1063 = 4252 parkas

c) What is CanadaLoon’s expected profit?

ANSWER:

4 x 2462 x $225 – 4252 x $25 = $2,109,500

d) Suppose for each colour the demand will either be zero (no units sold) or the demand will
be normally distributed with a mean of 2500 and standard deviation of 800 units. Each of these
possibilities has a probability of occurring 50% of the time.
How many units of each colour should CanadaLoon produce now?
Hint: Remember that they should produce to cover the critical ratio of demand.

ANSWER:

We need to cover 90% of the demand. This is the 50% at zero and another 80% of the remaining
50% for a total of 50% + 80% x 50% = 90%

So we want the z-value corresponding to 80%.

z-value = 0.842
Order quantity = 2500 + 0.842 x 800 = 3174 units.

e) How many units will it expect to have left over from each colour?

ANSWER:

Expected lost sales = Pr(Demand is non-zero) x # sales lost given it is non-zero

= 50% x 800 x L(z) = 50% x 800 * 0.112 = 45.

Expected demand = 50% x 2500 = 1250

Expected sales = 1250 – 45 = 1205
Expected leftover = 3174 – 1205 = 1969

Alternative solution: If demand is 0, there are 3174 units left over. This occurs 50% of the time.

If demand is greater than 0, there are 800 x L(z) = 800 x 0.112 = 90 sales lost. In this case,
average sales = 2500 – 90 = 2410.

Number of left over units equals 3174 – 2410 = 764 units. This occurs 50% of the time.

Average number left over = 50% x 3174 + 50% x 764 = 1969 units.