Question

Managers at Fluid Induction Industries are reviewing the economic feasibility of manufacturing a part that the company currently purchases from a supplier. Forecasted demand for this part is 16,800 units. Fluidoperates 250 days per year.

Fluid’s financial analysts established the cost of 9% for the use of funds for investments within the company. Also, over the past year $2,200,000 was the average investment in the company’s inventory. Accounting information shows that a total of $101,000 was spent on taxes and insurance related to the company’s inventory. Additionally, an estimated $29,000 was lost to inventory shrinkage, this included broken and damaged goods, and pilferage. $100,000 was spent on warehouse overhead, including expenses for heating and lighting.

Two hours are required to process and coordinate an order for the part regardless of the quantity ordered. Purchasing salaries average $28 per hour, including benefits. A detailed accounting analysis on 1,250 orders revealed that $25,000 was expensed for internet, paper and postage directly related to this ordering process.

Lead time for this part is one-week. The use of the part during the lead time is normally distributed with a mean of 960 units and a standard deviation of 16 units. The company’s policy regarding stock-outs is that one stock-out per year is permitted.

The company has a current contract to purchase the part from the supplier for $90 per unit. Fluid has increased its manufacturing capacity and is considering producing the part in house. The utilization of the increased capacity will produce at a rate of 4,800 units per month with up to 5 months of production time available. Management believes that with a two-week lead-time it can schedule the production of the part when needed. . The use of the part during the lead time is normally distributed with a mean of 1,280 units and a standard deviation of 200 units. Production costs are estimated at $76.50 per unit.

A major concern for the company is the fact that it will take two full 8 hour shift to set up the equipment. The total cost of labor is estimated to be $150 per hour.

Managerial Report.

Develop a managerial report that will address the question as to whether the company should purchase or manufacture the part itself. Include the following factors in your report:

1. An analysis of the holding cost.

2. An analysis of the ordering cost.

3. An analysis of setup cost.

4. Develop an inventory for ordering a quantity form the supplier and producing a quantity in house.

5. Include such information as Q, number of orders/production runs, cycle time, ROP, amount of safety stock, expected maximum inventory, annual cost of the units purchase or manufactured.

6. Make a recommendation to management whether the company should purchase or manufacture the part and the cost savings associated with your recommendation.

Answer 1

Management Report

Wager Fabricating Company is reviewing the economic feasibility of manufacturing a part that it currently purchases for a supplier.

Annual demand	3200	Units
Operated per year	250	days
Cost of capital	14%

1. An analysis of the holding costs, including the appropriate annual holding cost rate.

Solution:

Investment in inventory	$6,00,000
Tax and insurance on inventory	$24,000
Lost due to inventory shrinkage	$9,000
Warehouse ohs	$15,000
Inventory Carrying cost	$6,48,000
Inventory Carrying cost per unit	$202.50

2. An analysis of ordering costs, including the appropriate cost per order from the supplier.

Solution:

Cost of per order	$56
Telephone exp.	$19
($2375 for 125 order
Inventory ordering cost	$75

3. An analysis of setup costs for the production operation.

Solution:

Set up cost ($50 per hour for 8 hours)

$400

4. A development of the inventory policy for the following two alternatives:

a. Ordering a fixed quantity Q from the supplier

Solution: Ordering fixed quantity = mean= 64 units per week

b. Ordering a fixed quantity Q from in-plant production

Solution: Ordering fixed quantity = mean= 128 units per week

5. Include the following in the policies of parts 4(a) and (b):

a. Optimal quantity Q*

Solution: Used below formula to Calculate EOQ

EOQ =Sqrt(2*3200*75)/202.50

         = 14 units

b. Number of order or production runs per year

Solution:
No. of orders = 3200/14= 229 orders
No. of production=3200/128= 25 runs

c. Cycle time

Solution:

Cycle Time

Manufacture – 2 weeks

Buying – 1 week

d. Reorder point

Solution:

ROP= d x L

Buying = 3200/250*1= 13 units

Manufacture = 3200/250*2 = 26 units

e. Amount of safety stock

Solution:

At 1% stock out risk corresponds to a service level of 99%. This service level corresponds to z = 2.3.

Mean = 64 units & std. deviation = 40.

Safety Stock =ROL+ z std deviation

Buying=13+2.3(10)= 13+23=36 units

Safety stock = 23*202.50= $ 4657.50

f. Expected maximum inventory

Solution:

Maximum inventory = ROL-minimum usage x minimum reorder period + EOQ

= 13+36 = 49 units

g. Average inventory

Solution:

Annual demand = 3200 units

No. of days = 250

Average inventory = 3200/250= 13 units

h. Annual holding cost

Solution:

Annual holding cost = $ 6,48,000

i. Annual ordering cost

Solution:

Annual holding cost = 14*75= $ 1050

j. Annual cost of the units purchased or manufactured

Solution:

Annual Cost of purchase = 3200*18=   $ 57600

Annual cost of manufacture = 3200*17= $ 54400

k. Total annual cost of the purchase policy and the total annual cost of the production policy.

Solution:

Annual Cost of purchase = 3200*18+648000+1050 = $ 706650

Annual cost of manufacture = 3200*17+ 400+648000 = $ 702800

6. Make a recommendation as to whether the company should purchase or manufacture the part. What savings are associated with your recommendation as compared with the other alternative?

Solution: Company should manufacture the products because it will use additional capacity and saving cost by $3850. I have considering holding cost same in both scenario because if company is manufacturing the products then they have to keep inventory.

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