A store must commit to a stock quantity of a particular item before demand for that item will be know. Historically, demand for this item follows this probability distribution:
Demand (X) P(Demand = X)
10 0.20
11 0.35
12 0.30
13 0.10
14 0.05
The item in question has a retail price of $70, a wholesale cost of $60, and a salvage value of $8.
Suppose this store inadvertently stocked one more unit than is optimal. By how much would this store’s expected value decline?
Expert Answer
Demand (X) Prob Cumulative
Prob
10 0.20 0.20
11 0.35 0.55
12 0.30 0.85
13 0.10 0.95
14 0.05 1.00
Cost of understocking (Cu) = Sales price – wholesale cost = 70 – 60 = 10
Cost of overstocking (Co) = Wholesale cost – salvage value
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