QUESTION 1 A local retail store must place orders for Christmas in advance. Assu

Question

QUESTION 1

A local retail store must place orders for Christmas in advance. Assume that each ornament costs the chain $4. Furthermore, assume that each ornament can be sold for a retail price of $10. If the ornaments are still on the shelves after Christmas, they cannot be sold. The probability distribution of consumer demand for these ornaments (in hundreds) during the upcoming Christmas season has been assessed by the market research specialists and is presented below. Finally, assume that the chain must purchase the ornaments in lots of 100 units.

Demand (in hundreds)

Probability

4

0.20

5

0.70

6

0.10

What is the optimal strategy for order quantity?

Demand (in hundreds)

Probability

4

0.20

5

0.70

6

0.10

Explanation / Answer

Expected number of sales in thousands = 4x0.2+5x0.7+6x0.1 = 4.9

There are 2 options available here, buying 4 lots of 100 units each or 5 units of 100 units each

If 4 lots are brought, profit = 400x10 - 400x4 = $2400

If 5 lots are bought, profit = 490x10 - 500x4 = $2900

So, to maximize profit, the optimum strategy is to buy 5 lots

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