Question

Consider two products, X and Y, that have identical cost, retail price, and demand parameters and the same short selling season (the summer months from May through August). The newsvendor model is used to manage inventory for both products. Product X is to be discontinued at the end of the season this year and the leftover inventory will be salvaged at 75 percent of the cost. Product Y will be reoffered next summer, so any leftovers this year can be carried over to the next year while incurring a holding cost on each unit left over equal to 20 percent of the product's cost. The quantity of each product is selected to maximize expected profit. How do those quantities compare?

Answer 1

Stocking quantity of product B is higher

Step-by-step explanation:

Overage cost for Product A(Co)=100-75=25%

Overage cost for Product B (Co)=20%

The underage cost (Cu) for both the products is same hence critical ratio i.e, Cu/(Cu+Co) is lower for product A than Product B which means product B should will be stocked more compare to product A

So the correct answer will be stocking quantity of product B is higher

Answer 2

Answer: b. stocking quantity of product B is higher.

Step-by-step explanation:

We are using the Newsvendor model and are told that the products have identical cost, retail price, and demand parameters and the same short selling season.

Using this model, it is important to understand 2 terminologies for this question, Overage cost and Underage costs.

Overage Costs is the cost of unused inventor and is calculated by subtracting Salvage Value from the cost price.

Underage costs are costs arising from unmet Demand. In this scenario they are the same because both products share the same demand.

The Overage costs for the products are,

Overage cost for Product X =100-75

=25%

Overage cost for Product Y = 20%

When deciding which product to stick more of we look at the one with the higher CRITICAL RATIO.

The formula of which is,

= Cu/(Cu+Co)

Where,

Cu is the Underage cost,

Co is the Overage cost

As earlier mentioned, both have the same Underage cost meaning that B will give a higher CRITICAL ratio as it's Co is smaller.

Product B should therefore be stocked more than Product A.