33) Store A uses the newsvendor model to manage its inventory. Demand for its product is normally distributed with a mean of 500 and a standard deviation of 300. Store A purchases the product for $10 each unit and sells each for $20. Inventory is salvaged for $5. Which of the following statements is TRUE if Store A increases its in-stock probability from 98% to 99%?

A) Expected inventory increases.

Explanation:

The newsvendor model is used by supply chain management to determine inventory levels. It applies math and economics into a sales model where new products are very profitable, but they are also very perishable (last one or two days at most). The unsold inventory is sold at a very low salvage price, but each unit sold has a very high contribution margin.

In this case, each unit sold generates $10 in profit (100% markup), but each unit not sold results in a $5 loss (50% loss).

The mathematical formula for the newsvendor model is:

CF = CU ÷ (CU + CO)

When the in-stock probability increases, the CU increases, therefore CF increases, resulting in higher inventory levels.

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