How many books should Dan order if he wants to achieve a 95 percent in-stock probability?What is the cost of underestimation?

MGT 3501 – Practice Problems – Newsvendor Model
1. Johnson Electronics sells electrical and electronic components through catalogs. Catalogs are printed once every two years. Each printing run incurs a fixed cost of $25,000, with a variable production cost of $5 per catalog. Annual demand for catalogs is estimated to be normally distributed with a mean of 16,000 and standard deviation of 4,000. Data indicates that, on average, each customer ordering a
catalog generates net revenue of $35 from sales. Assuming that Johnson wants only one printing run in each year cycle, how many catalogs should be printed in each run?
2. Dan McClure owns a private bookstore in New Hope, Pennsylvania. He must decide how many copies to order of a new book, Power and Self-Destruction. The book’s retail price is $20 and the wholesale price is $12. The publisher will buy back the retailer’s leftover copies at a full refund, but McClure Books incurs $4 in shipping and handling cost for each book returned to the publisher. Dan believes his demand forecast can be represented by a normal distribution with mean 200 and standard deviation 80.
a. What is the cost of underestimation?
b. What is the cost of over-estimation?
c. What order quantity maximizes Dan’s expected profit?
d. Dan prides himself in good customer service. In fact, his motto is “McClure got what you want to read.” How many books should Dan order if he wants to achieve a 95 percent in-stock probability?

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