Question

Assume that you are considering purchasing an item that you currently manufacture. The manufacturing department of your firm has informed you that the average cost of the item produced inhouse is $66.00 per unit. You can produce as you need it, so no finished goods inventory is kept when you manufacture it yourself. Accounting has informed you that 9.1% of the fixed costs will not be saved if you stop producing the item. The item has associated with it seasonal quarterly demand as follows:

	Quater 1	Quarter 2	Quarter 3	Quarter 4
Demand	200	300	400	200

a. Calculate the total annual variable cost associated with manufacturing the item yourself in-house: Total Annual Variable Cost:_____________________________

After receiving the RFQs back from a list of suppliers, you decide to go with a supplier that will sell the item to you at a unit cost of $52. It has been calculated that the cost to place an order with this supplier is $25 per order. The holding cost is estimated to be 18% of unit cost per year with no need for safety stock since the seller you would work with is local and has the excess capacity needed to supply the items as you need them.

b. Using the Economic Order Quantity (EOQ) Model, evaluate the Total Annual Cost associated with outsourcing this item. Please fill out the table below (round to 2 decimal places):

	Quarter 1	Quarter 2	Quarter 3	Quarter 4
Order Quantity (per order)
COGS per Quarter
Orderting Cost per Quarter
Holding Cost per Quarter
Quarterly Total Cost

Overall Total Annual Cost:

c. Given the annual cost analysis above, should you continue to manufacture the item in-house or purchase it from this supplier? Support you conclusion with savings figures.

Answer 1

a) $72,600

b) $59,023

c) Purchase from supplier as it results in savings of $ 13,576 (= $72,600-$59,023)