Question

In January 2009, Tom Sosa, the purchasing manager, received a telephone call from their Columbus, Indiana, diesel engine supplier informing him that effective June they were no longer producing the D-342 diesel engines at the Columbus plant. The D-342 engine sales were decreasing and would no longer be in their product line. Tom was in shock. He was now forced to deal with the sole supplier of the D-342 located in Portland, Oregon. The most recent price schedule submitted by the Oregon engine supplier is given below:

Units per Order	Unit Price
Less than or equal to 100	$ 4,800
Between 100 and 200	4,700
Greater than 200	4,550

The prices had been basically the same as the Columbus supplier except that they are F.O.B. Portland. The traffic department informed Tom that the transportation cost per hundredweight is $10 for carload lots of 50,000 pounds. The less than carload rate is $15 per hundredweight. The replenishment cycle normally takes one week.

BACKGROUND

Tom Sosa, the supply manager for MARS, Inc. was contemplating several significant changes in the D-342 diesel engine market. Mr. Sosa was concerned because in its production of the 98-D loader, MARS used 10 diesel engines each working day of the month. (MARS operated on a 20-day-per-month schedule.) Each engine weighs 500 pounds. Engine orders are currently placed every Monday morning. For the past 10 years, the D-342 engines had been produced in only two locations in the United States, one in Columbus, Indiana, and the other in Portland, Oregon. Mr. Sosa felt fortunate that the Columbus producer was located approximately 30 miles from his facility. The Columbus supplier offered just-in-time delivery service at no charge to MARS.

MARS implemented lean manufacturing in 2002. The kanban-controlled JIT production system was implemented based on the premise of minimizing work-in-process inventories (waste) by reducing lot sizes in order to increase production efficiency and product quality.

ACTION TAKEN BY TOM

Mr. Sosa compiled cost and warehouse capacity data on the D-342 engine from the accounting department. See Table C17.1.

Mr. Sosa wonders what effects these new developments will have on his cost structure.

Assignment Questions

  1.  What were MARS’s total costs per year prior to the new price structure when the diesel engine price was $4,800? Was MARS using the EOQ method?

TABLE C17.1
Cost and Warehouse Capacity

Cost of unloading engines into warehouse	$0.25 (per 100/wt)
Order processing cost per requisition	$100
Warehouse capacity	200 units
Outside warehouse costs	$39 per year per unit*
Expediting cost per requisition	$50
Inventory carrying cost	38%

2.   With volume discounts and warehouse constraints, what is the best ordering quantity?

Answer 1

Answer to question no (1):

To determine: Total cost per year prior to the new price structure incurred by MARS, when the engine price was $4,800 and identify whether MARS is using the EOQ method

Given information:

Total workdays in a month are 20 days.

MARS used 10 units of engines every working day in a month.

Total number of units used in a month will be 200 units (10 units × 20 days)

New orders are placed every Monday. So, the number of times the orders are placed in a month will be 4.

Total number of ordered placed annually will be 48 (4 orders in a month × 12 months)

Therefore, the total units ordered annually will be 2400 units (48 orders annually × 50 units weekly)

Required formula:

Total costs per year = Total units ordered annually × Unit price per order

Calculation:

Step 1: Identify the eligible unit price per order from the information given in the question.

MARS is placing an order of 50 units per week. Therefore, they place an order of 200 units every month.

Based on the information given in the question, the unit price per order is $4,700 for units ordered between 100 and 200.

Step 2: Calculate the total cost per year prior to the new price structure.

Therefore, the total costs per year prior to the new price structure are $11,280,000.

Step 3: Identify whether MARS is using the EOQ method.

According to the given information, MARS, Inc had been using the Just-in-time (JIT) method. This can be said because the company was ordering diesel engines without facing any problems with making payments for different costs. This includes the cost of transportation of the diesel engines to the warehouse at 10 dollars per hundredth pound and the cost to unload them.

The company could start the implementation of the economic order quantity (EOQ) method only after partnering with the plant in Columbus. The company was able to get rid of waste through the use of lean and mean operations. Moreover, not having a back stock could also make them lose money.

_______________________________________________________________

Answer to question no (2):

To determine: Best ordering quantity

Solution: Using the information given in the question, the best order quantity at different discount rates is as follows.

Calculate the total cost at unit price per order of $4,800.

Step 1: Calculate the total cost with volume purchase discount constraint.

Step 2: Calculate the total cost with warehouse constraint.

Calculate the total cost at unit price per order of $4,700.

Step 1: Calculate the total cost with volume purchase discount constraint.

Step 2: Calculate the total cost with warehouse constraint.

Calculate the total cost at unit price per order of $4,550.

Step 1: Calculate the total cost with volume purchase discount constraint.

Step 2: Calculate the total cost with warehouse constraint.

Based on the volume discounts and warehouse constraints computed above, the best ordering quantity for MARS, Inc is the discounted amount of $250 on buying more than 200 units, at a unit price of $4,550. At present, MARS, Inc is making orders of 200 units in a month. It is capable of selling 50 of the ordered units in a week. Therefore, it would be profitable for the company to continue ordering the same units in a month, i.e. 200. This would not incur any storage costs, as the company can rotate its inventory in and out without any problem.

Thus, the best ordering quantity for MARS, Inc is the discounted amount of $250 on buying more than 200 units, at a unit price of $4,550.