Question

Topic 7

Book: Operations and Supply Chain Management Jacobs & Chase 14e

14. Merrimac Manufacturing has always purchased a certain component part from a supplier on the East Coast for $40 per part. The supplier is reliable and has maintained the same price structure for years. Recent improvements in operations and reduced product demand have cleared up some capacity in Merrimac’s own plant for producing component parts. The particular part in question can be produced internally by Merrimac at $25 per part, with an annual fixed investment of $30,000.

a) Over what range (quantity) of product would each of the two options be the preferred one?

b) As an alternative, a new supplier located nearby is offering to produce parts on the following cost schedule. For the first 100 parts, the cost is $52 per part. For each part in excess of 100, the cost per unit drops to $35 per part. Considering just the two suppliers, over what range (quantity) of product would each supplier be the preferred one?

Answer 1

(a)

Let us consider X number of parts will be purchased by Merrimac

cost of unit Product = $40

Cost of buying of X units= 40* X

Fixed internal costs for production = $30,0000

Cost of production of unit part =$25

Cost of production of X units by Merrimac = No of units * units part price + fixed annual costs

= X * 25 + 30, 000

Assume that For X units the cost of production and buying will be equal then

40* X=X * 25 + 30, 000

40X-25X=30,000

15X=30,000

X=2,000 Units

if Merrimac produces 2000 units then the cost of buying is equal to production costs. if it produces less than 2000 quantities it costs more than buying due to the involvement of fixed annual costs.

If Merrimac wants annually less than 2,000 Quantities then the best option is to purchase from a supplier,  If it needs More than 2000 units then the best option is to produce itself which is more profitable.

(b)

Let us Consider x products to be purchased

Cost buying from new supplier= 52 *100 + 35 (x-100)

*Here for the first 100 units, the cost is $52 and for the rest, x-100 units price dropped to $35

Cost of buying x products from the old supplier = 40 * X

Consider the cost of buying x products from both the suppliers is the same, then

52 *100 + 35 (x-100)= 40 X

5200+35 X-3500= 40 X

5X=1700

X=340

If we purchase 340 units then the price at both suppliers will be equal

Let us calculate the price for purchasing 299 units

Old supplier= 299 *40 =11960

New Supplier = 100 *52+( 299-100)*35 =12165

It is evident if purchasing Qty is less than 340 Old supplier is profitable, similarly for more than 340 units New supplier will be profitable.

Hence, If Merrimac wants to purchase Quantities less than 340 then the old supplier is profitable if Merrimac wants to purchase more than 340 units then-new supplier is profitable due to discounts offered at the price.

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