I do not understand, the difference between stock out cost and expected stock out cost. How "expected stock Out" comes by multiplying 'probability and stock out cost'..?
For eg:- if you are maintaining 50 units of stock level... Some customers came for 100 units and it's probability is only 2%. That means 2% customers may ask for 100 units . If suppose stock out cost is 150 per unit . Then stock out cost is 50 Ã? 150 = 7500 But expectation to happen such a situation is only 2% . Then expected stock out cost is 7500 Ã? 2% =750. (So remember about provisions....We are providing expected losses as per prudence )
So, we check expected stock out cost =stock out costÃ?probability of happening such stock out (i. e,) probability which you find by using ad hoc basis. #in majority of this type of questions they try to ask optimum stock level Which is equal to, minimum of summation of(expected stock out cost +amount required to carry that safety stock,,(which is commonly called as holding /carrying/storage cost)