Question

The TEMKO Company encountered the problem of defects in some of its pur- chased tractor short-block castings. The short-block castings are used to build the R-208 tractor engines. TEMKO installs the heads, manifold, carburetor, and other engine parts, which consist of approximately 13 percent of the short-block casting purchase price. When the defects are discovered, the short blocks have to be disas- sembled and repaired. It takes approximately eight hours per repair. Even with this process, almost 4 percent of the incoming short blocks end up as scrap. In other words, approximately 10 out of every 100 units are repaired and 40 percent of the repaired short blocks are scrapped. Each short-block casting costs between $1,550 and $1,700 depending on the supplier. There is also a cost of downtime as- sociated with interruptions on the shop floor.
The internal labor cost of assembling each incoming short-block casting and repair as necessary is approximately $878 per short block. The estimated overhead, which is 150 percent of direct labor, consists of 33 percent variable and 67 percent fixed costs; the shop floor disruption cost is estimated to be $500 per disruption.
Recently, James Sun, the purchasing manager, released a request for quote (RFQ) for the short blocks to three prequalified suppliers of assembled tractor en- gines. However, only one supplier, ACE Manufacturing, Inc., showed an interest. ACE was a small startup company that was looking for work. In order to produce assembled R-208 engines, an investment in precision machinery of more than $1,500,000 would need to be made. ACE was willing to both invest in the neces- sary machine and guarantee at least 100 engines per month—provided TEMKO would contract with it as a sole source for the engines for the next three years. The price per engine would be $3,500 the first year, with an annual increase of 3 per- cent. TEMKO anticipated that they would need at least 1,000 finished engine as- semblies per year for the next five years. As the purchasing manager for TEMKO, how would you analyze this outsourcing decision? (Make sure your analysis is complete.)

1. Develop a unit cost breakdown for R-208 tractor engines utilizing both available current

data and assumptions in the process of calculations. State all assumptions

2. What would the estimated probable cost resulting from poor quality of incoming shortblocks

castings? Suggest probable solutions to this quality problem.

5. According to ACE Manufacturing, what would the resulting cost reduction from

outsourcing to ACE Manufacturing be? Discuss the probable sources of this cost reduction.

What would be the consequence of exploiting these sources to TEMKO and ACE

Manufacturing?

Answer 1

	AT
1. Per unit cost	Max. price	Min. Price
Cost of short block casting	1700	1550
Cost of all Other parts(13%*above)	221	202
Direct labor	878	878
VOH(878*150%*33%)	435	435
FOH(878*150%*67%)	882	882
Total cost/engine	4116	3947
Relevant/Variable cost	3234	3064

2.Estimated probable cost resulting from poor quality of incoming shortblocks
Per unit cost	same for both Max.& min. price
Direct labor	878
VOH(878*150%*33%)	435
Disruption cost/repair	500
Total relevant/variable cost /unit	1813

5.Resulting cost reduction as per ACE
Relevant/Variable cost(as in 1. above)	3234	3064
Re-work costs spread over good units
(1813*100)/(1000-40)	189	189
Total reduction cost/engine	3422	3253

Consequence to ACE Mfg.
Investment in m/c	-1500000
Sale in 5 yrs.
1000*3500=	3500000
1000*3605=	3605000
1000*3713=	3713000
1000*3825=	3825000
1000*3939=	3939000
Total	17082000
For ACE, it is worth investing

Consequence to TEMKO
As per 5. above,
beween both the ranges of price--ie. At maximum & minimum short-block castings available,
cost savings if outsourced (after considering alll associated re-work costs comes to:
Total cost reduction /engine	3422	3253
Ace's quote of $ 3500/engine
is costly &
hence NOT RECOMMENDED