CUSTOM FABRICATIONS Inc. is a bicycle manufacturing firm founded in 2000 that currently employs 126 people. The company produces custom bicycles in its factory located near Los Angeles, CA. Each bicycle is tailored to a rider based on a number of different measurements, including height, weight, inseam, and arm length. These measurements are taken at 30 professional bicycle shops around Southern California, which are certified to size CUSTOM FABRICATIONS cycles. By accepting orders only through licensed dealers, CUSTOM FABRICATIONS ensures that each bike matches its rider precisely. CUSTOM FABRICATIONS’ custom bikes are considered extremely high quality and the company takes pride in using only the best components sourced from around the world. Accordingly, CUSTOM FABRICATIONS purchases from a cast of hundreds of suppliers, chosen for their commitment to quality and reliability. Demand for CUSTOM FABRICATIONS’ cycles has grown exponentially in recent years. The surge in demand was somewhat unexpected and the company’s factory has been operating at capacity for over a year. As a result, current orders face a production backlog of approximately 5–6 weeks. The company’s operations have been further hampered by severe inefficiencies and control weaknesses attributed to its legacy accounting system. Your firm has been hired as an outside consultant to suggest improvements in the company’s accounting procedures. The following paragraphs describe the company’s expenditure cycle. Purchases System All purchases of raw materials are initiated in the CUSTOMFABRICATIONS’ purchasing department. A clerk in the department monitors inventory levels from his PC, which is linked to the inventory subsidiary ledger. Once a part needs to be replenished, he creates a hard-copy purchase order. One copy is mailed to the vendor, a blind copy of the purchase order is sent to the warehouse, and the third copy is filed in the purchasing department. Typically within 3–5 business days, the warehouse receives the ordered parts and the packing slip from the vendor, which the warehouse clerk reconciles with the blind copy of the purchase order. Once the reconciliation is complete, the warehouse clerk prepares a three-part hard-copy receiving report stating the quantity and condition of the items received. One copy of the receiving report is sent to the general ledger department to update the digital inventory control account. The second copy is sent to the accounts payable department, and the third is sent to the purchasing department to update the inventory subsidiary ledger. Within a week, the mail room receives the supplier’s invoice, which is immediately sent to the accounts payable department. The AP clerk reconciles the invoice with the receiving report and then records a liability in the AP subsidiary ledger from the department PC. Finally, the clerk prints an AP summary from the terminal and sends it to the general ledger clerk. Cash Disbursements System The accounts payable clerk regularly checks the accounts payable subsidiary account at his terminal to ensure timely payment to vendors. For those items due for payment, he sends approval in the form of a payment voucher to the cash disbursements department. For control purposes, cash disbursements are processed manually. The details of the check are recorded in the hard-copy cash disbursements journal, and the check is mailed to the vendor. The clerk then prepares a journal voucher and sends it to the general ledger. Once the general ledger clerk receives the journal voucher, the AP summary, and the receiving report, she updates the affected general ledger accounts from the department PC. Required a. Create a data flow diagram of the current system. b. Create a system flowchart of the existing system. c. Analyze the physical internal control weaknesses in the system. d. Describe the risks associated with these control weaknesses. e. (Optional) Prepare a system flowchart of a redesigned computer-based system that resolves the control weaknesses that you identified. Explain your solution.

Backyard Bulldog Barbecue Sauces, Inc., founded by Jefe Allen, produces a variety of barbecue sauces for use in outdoor grilling. Jefe is having difficulty understanding the relationship between different types of costs, revenue and profit. Jefe has asked you to clarify this issue for him by answering the following questions.

1. Define the different types of costs that Backyard Bulldog Barbecue Sauces, Inc. will incur along with several examples of each.

2. How could overly optimistic sales estimates potentially harm Jefe's business?

3. Explain how cost-volume-profit analysis can help Jefe make good managerial decisions regarding Backyard Bulldog Barbecue Sauces, Inc.?

Illinois Bio Technologies

Illinois Bio Technologies (IBTECH) was founded in Rosemont, Illinois, in 1992 by Kelly O'Brien, David Roberts, and Barbara Smalley. O'Brien and Roberts, both MDs, were on the research faculty at the Chicago Medical School at the time; O'Brien specialized in biochemistry and molecular biology, and Roberts specialized in immunology and medical microbiology. Smalley, who has a PhD, served a department chair of the Microbiology Department at the same school.

The company started as a research and development firm, which performed its own basic research, obtained patents on promising technologies, and then either sold or licensed the technologies to other firms which marketed the products. In recent years, however, the firm has also contracted to perform research and testing for larger genetic engineering and biotechnology firm, and for the U.S. government. Since its inception, the company has enjoyed enormous success - even its founders were surprised at the scientific breakthrough made and the demand for its services. One event that contributed significantly to the firm's rapid growth had been the AIDS research. Both the U.S. government and private foundations have spent billions of dollars in AIDS research, and IBTECH had the right combination of skills to garner significant grant funds, as well as perform as a subcontractor to other firm receiving AIDS research grant.

The founders were relatively wealthy individuals when they started the company, and they had enough confidence in the business to commit most of their own funds to the new venture. Still, the capital requirement brought on by extremely rapid growth soon exhausted their personal funds, so they were forced to raise capital from outside sources. First, in 2001, the firm borrowed heavily, and then in 2003, when it used up its conventional debt capacity, it issued $15 million of preferred stock. Finally, in 2006, the firm had an initial public offering (lPO) which raised $50 million of common equity. Currently, the stock trades in the over-the-counter market, and it has been selling at about $25 per share.

IBTECH is widely recognized as the leader in an emerging growth industry, and it won an award in 2008 for being one of the 100 best-managed small companies in the United States. The company is organized into two divisions: (1) the Clinical Research Division and (2) the Genetic Engineering Division. Although the two divisions are housed in the same buildings, the equipment they use and their personnel are quite different. Indeed, there are few synergies between the two divisions. The most important synergies lay in the general overhead and marketing areas. Personnel, payroll, and similar functions are all done at the corporate level, while technical operations at the divisions are completely separate.

The Clinical Research Division conduct most of the firm' AIDS research. Since most of the grant and contracts associated with AIDS research are long-term in nature, and since billion of new dollars will likely be spent in this area, the business risk of this division is low. Conversely, the Genetic Engineering Division works mostly on in-house research and short-term contracts where the funding, duration, and payoff are very uncertain. A line of research may look good initially, but it is not unusual to hit some snag, which preclude further exploration. Because of the uncertainties inherent in genetic research, the Genetic Engineering Division is judged to have high business risk.

The founders are still active in the business, but they no longer work 70-hour week. Increasingly, they are enjoying the fruits of their past labor, and they have let professional managers take over day-to-day operations. They are all on the board of director, though, and David Roberts is chairman.

Although the firm's growth has been phenomenal, it has been more random than planned. The founders would simply decide on new avenue of research, and then count on the skills of the research teams-and good luck-to produce commercial successes. Formal decision structures were almost nonexistent, but the company's head start and its bright, energetic founder easily overcame any deficiencies in its managerial decision processes. Recently, however, competition has become stiffer, and such large biotechnology firms such as Genentech, Amgen, and even Bristol-Myers Squibb have begun to recognize the opportunities in IBTECH's research line. Because of this increasing competition, IBTECH's founders and board of directors have concluded that the firm must apply state-of-the-art technique in its managerial processes as well as in its technological processes. As a first step, the board directed the financial vice president, Gary Hayes, to develop an estimate for the firm's cost of capital and to use this number in capital budgeting decisions. Hayes, in turn, directed IBTECH's treasurer, Julie Owens, to have a cost of capital estimate on his desk in one week. Owens has an accounting background, and her primary task since taking over as treasurer has been to deal with the banks. Thus, she is somewhat apprehensive about this new assignment especially since one of the board members is her former Kean University finance professor.

Table 1

Illinois Bio Technologies, Inc.

Balance Sheet for the Year Ended December 31, 2019

(In Millions of Dollars)

To begin, Owen reviewed IBTECH's 2019 balance sheet, which is shown in Table 1. Next, she assembled the following data:

• IBTECH's long-term debt consists of 9.5 percent coupon, semiannual payment bonds with fifteen year remaining to maturity. The bonds last traded at a price of $891 per $1,000 par value bond. The bonds are not callable and they are rated BBB.
• The founders have an aversion to short-term debt, so the firm uses such debt only to fund cyclical working capital needs.
• IBTECH' federal-plus-state tax rate is 40 percent.
• The company’s preferred stock pays a dividend of $2.50 per quarter and has a par value of $100. It is non-callable and perpetual, and it is traded in over-the-counter market at a current price of $104 per share. A flotation cost of $2 per share would be required on a new issue of preferred stock.
• The firm's last dividend (D₀) was $1.09, and dividends are expected to grow at about a 10 percent rate in the foreseeable future. Some analyst expect the company' recent growth rate to continue, other expect it to go to zero as new competition enter the market, but the majority anticipate that a growth rate of about 10 percent will continue indefinitely.
• An important minority of analyst have noted that over the last few years, the company has had a 14 percent average return on equity (ROE) and has paid out about 25 percent of its net income as dividends. They believe the firm' expected future growth rate, g should be based on this information and used to estimate the cost of capital.
• The firm's per share dividend payment over the past five year has been a follow

• IBTECH’s common stock now sells at a price of about $25 per share. The company has 5 million common shares outstanding.
• The current yield on long-term T-bonds is 8 percent, and a prominent investment-banking firm has recently estimated that the market risk premium is six percentage points over Treasury bond. The firm' historical beta, as measured by several analysts who follow the stock, is 1.2.
• The required rate of return on an average (A-rated) company's long-term debt is 10 percent.
• IBTECH is forecasting reinvested earnings of $1,800,000 and depreciation of 4,500,000 for the coming year.
• IBTECH's investment banker believes that a new common tack issue would involve total flotation costs - including underwriting costs, market pressure from increased supply, and market pressure from negative signaling effect- of 30 percent.
• The market value target capital structure call for 30 percent long-term debt, 10 percent preferred stock, and 60 percent common stock.

Now assume that you were recently hired as Julie Owen’s assistant, and she has given you the task of helping her develop the firm's cost of capital. You will also have to meet with Gary Hayes and, possibly, with the president and the full board of directors (including the Kean University Professor) to answer any question they might have. With this in mind, Owens wrote up the following questions to get you started with your analysis. Answer them, but keep in mind that you could be asked further questions about your answer, so be sure you understand the logic behind any formula or calculation you use. In particular, be aware of potential conceptual or empirical problems that might exist.

9. What is your estimate of IBTECH's cost of new common stock, r_e? What are some potential

Illinois Bio Technologies

Illinois Bio Technologies (IBTECH) was founded in Rosemont, Illinois, in 1992 by Kelly O'Brien, David Roberts, and Barbara Smalley. O'Brien and Roberts, both MDs, were on the research faculty at the Chicago Medical School at the time; O'Brien specialized in biochemistry and molecular biology, and Roberts specialized in immunology and medical microbiology. Smalley, who has a PhD, served a department chair of the Microbiology Department at the same school.

The company started as a research and development firm, which performed its own basic research, obtained patents on promising technologies, and then either sold or licensed the technologies to other firms which marketed the products. In recent years, however, the firm has also contracted to perform research and testing for larger genetic engineering and biotechnology firm, and for the U.S. government. Since its inception, the company has enjoyed enormous success - even its founders were surprised at the scientific breakthrough made and the demand for its services. One event that contributed significantly to the firm's rapid growth had been the AIDS research. Both the U.S. government and private foundations have spent billions of dollars in AIDS research, and IBTECH had the right combination of skills to garner significant grant funds, as well as perform as a subcontractor to other firm receiving AIDS research grant.

The founders were relatively wealthy individuals when they started the company, and they had enough confidence in the business to commit most of their own funds to the new venture. Still, the capital requirement brought on by extremely rapid growth soon exhausted their personal funds, so they were forced to raise capital from outside sources. First, in 2001, the firm borrowed heavily, and then in 2003, when it used up its conventional debt capacity, it issued $15 million of preferred stock. Finally, in 2006, the firm had an initial public offering (lPO) which raised $50 million of common equity. Currently, the stock trades in the over-the-counter market, and it has been selling at about $25 per share.

IBTECH is widely recognized as the leader in an emerging growth industry, and it won an award in 2008 for being one of the 100 best-managed small companies in the United States. The company is organized into two divisions: (1) the Clinical Research Division and (2) the Genetic Engineering Division. Although the two divisions are housed in the same buildings, the equipment they use and their personnel are quite different. Indeed, there are few synergies between the two divisions. The most important synergies lay in the general overhead and marketing areas. Personnel, payroll, and similar functions are all done at the corporate level, while technical operations at the divisions are completely separate.

The Clinical Research Division conduct most of the firm' AIDS research. Since most of the grant and contracts associated with AIDS research are long-term in nature, and since billion of new dollars will likely be spent in this area, the business risk of this division is low. Conversely, the Genetic Engineering Division works mostly on in-house research and short-term contracts where the funding, duration, and payoff are very uncertain. A line of research may look good initially, but it is not unusual to hit some snag, which preclude further exploration. Because of the uncertainties inherent in genetic research, the Genetic Engineering Division is judged to have high business risk.

The founders are still active in the business, but they no longer work 70-hour week. Increasingly, they are enjoying the fruits of their past labor, and they have let professional managers take over day-to-day operations. They are all on the board of director, though, and David Roberts is chairman.

Although the firm's growth has been phenomenal, it has been more random than planned. The founders would simply decide on new avenue of research, and then count on the skills of the research teams-and good luck-to produce commercial successes. Formal decision structures were almost nonexistent, but the company's head start and its bright, energetic founder easily overcame any deficiencies in its managerial decision processes. Recently, however, competition has become stiffer, and such large biotechnology firms such as Genentech, Amgen, and even Bristol-Myers Squibb have begun to recognize the opportunities in IBTECH's research line. Because of this increasing competition, IBTECH's founders and board of directors have concluded that the firm must apply state-of-the-art technique in its managerial processes as well as in its technological processes. As a first step, the board directed the financial vice president, Gary Hayes, to develop an estimate for the firm's cost of capital and to use this number in capital budgeting decisions. Hayes, in turn, directed IBTECH's treasurer, Julie Owens, to have a cost of capital estimate on his desk in one week. Owens has an accounting background, and her primary task since taking over as treasurer has been to deal with the banks. Thus, she is somewhat apprehensive about this new assignment especially since one of the board members is her former Kean University finance professor.

Table 1

Illinois Bio Technologies, Inc.

Balance Sheet for the Year Ended December 31, 2019

(In Millions of Dollars)

To begin, Owen reviewed IBTECH's 2019 balance sheet, which is shown in Table 1. Next, she assembled the following data:

• IBTECH's long-term debt consists of 9.5 percent coupon, semiannual payment bonds with fifteen year remaining to maturity. The bonds last traded at a price of $891 per $1,000 par value bond. The bonds are not callable and they are rated BBB.
• The founders have an aversion to short-term debt, so the firm uses such debt only to fund cyclical working capital needs.
• IBTECH' federal-plus-state tax rate is 40 percent.
• The company’s preferred stock pays a dividend of $2.50 per quarter and has a par value of $100. It is non-callable and perpetual, and it is traded in over-the-counter market at a current price of $104 per share. A flotation cost of $2 per share would be required on a new issue of preferred stock.
• The firm's last dividend (D₀) was $1.09, and dividends are expected to grow at about a 10 percent rate in the foreseeable future. Some analyst expect the company' recent growth rate to continue, other expect it to go to zero as new competition enter the market, but the majority anticipate that a growth rate of about 10 percent will continue indefinitely.
• An important minority of analyst have noted that over the last few years, the company has had a 14 percent average return on equity (ROE) and has paid out about 25 percent of its net income as dividends. They believe the firm' expected future growth rate, g should be based on this information and used to estimate the cost of capital.
• The firm's per share dividend payment over the past five year has been a follow

• IBTECH’s common stock now sells at a price of about $25 per share. The company has 5 million common shares outstanding.
• The current yield on long-term T-bonds is 8 percent, and a prominent investment-banking firm has recently estimated that the market risk premium is six percentage points over Treasury bond. The firm' historical beta, as measured by several analysts who follow the stock, is 1.2.
• The required rate of return on an average (A-rated) company's long-term debt is 10 percent.
• IBTECH is forecasting reinvested earnings of $1,800,000 and depreciation of 4,500,000 for the coming year.
• IBTECH's investment banker believes that a new common tack issue would involve total flotation costs - including underwriting costs, market pressure from increased supply, and market pressure from negative signaling effect- of 30 percent.
• The market value target capital structure call for 30 percent long-term debt, 10 percent preferred stock, and 60 percent common stock.

Now assume that you were recently hired as Julie Owen’s assistant, and she has given you the task of helping her develop the firm's cost of capital. You will also have to meet with Gary Hayes and, possibly, with the president and the full board of directors (including the Kean University Professor) to answer any question they might have. With this in mind, Owens wrote up the following questions to get you started with your analysis. Answer them, but keep in mind that you could be asked further questions about your answer, so be sure you understand the logic behind any formula or calculation you use. In particular, be aware of potential conceptual or empirical problems that might exist.

1. Cost of reinvested earnings using CAPM:
   1. Why is there a cost associated with reinvested earnings?
   2. What is IBTECH's estimated cost of reinvested earning using the CAPM approach?
   3. Why might one consider the T-bond rate to be a better estimate of the risk-free rate than the T-bill rate? Can you think of an argument that would favor the use of the T-bill rate?
   4. How can IBTECH obtain a market risk premium for use in a CAPM cost-of-equity calculation? Discuss both the possibility of obtaining an estimate from some other organization and also the ways in which IBTECH could calculate a market risk premium in-house.
   5. Calculate the cost of reinvested earnings (r_s ) using CAPM

Forecasting: Measuring Forecast Accuracy

Tires for You, Inc. (TFY), founded in 1987, is an automotive repair shop specializing in replacement tires. Located in Altoona, Pennsylvania, TFY has grown successfully over the past few years because of the addition of a new general manager, Ian Overbaugh. Since tire replacement is a major portion of TFY’s business (it also performs oil changes, small mechanical repairs, etc.), Ian was surprised at the lack of forecasts for tire consumption for the company. His senior mechanic, Skip Grenoble, told him that they usually stocked for this year what they sold last year. He readily admitted that several times throughout the season, stockouts occurred and customers had to go elsewhere for tires. Although many tire replacements were for defective of destroyed tires, most tires were installed on cars whose original tires had worn out. Most often, four tires were installed at the same time. Ian was determined to get a better idea of how many tires to hold in stock during the various months of the year. Listed below is a summary of individual tire sales by month.

Period 2010 October November December 2011 January February March April May June July August September October November December Tires Used 9,800 11,000 11,000 9,700 8,800 9,300 10,700 9,300 8,700 10,200 10,800 9,700 10,200 11,600 11,100

Ian has hired you to determine the best technique for forecasting TFY demand based on given data.

1. Calculate forecasts for August, 2011 through December 2011 using a simple four-month moving average. Round your answers to the whole number.

Period 2011 August September October November December Forecasts

2. Calculate forecasts for August, 2011 through December 2011 using the exponential smoothing method with α = 0.4. Assume the forecast for August, 2011 is 11,000. Round your answers to the whole number.

Period 2011 August September October November December Forecasts 11,000

3. Calculate the forecast errors, the MAD, the MSE, and the MAPE for the forecasts you made in Question 1. Use the actual sales data for 2011. Round your answers to the whole number.

Period August September October Actual Sales 10,800 9,700 10,200 Forecasts Errors Absolute Error Error2 Absolute % Error November 11,600 December 11,100 MAD= MSE= MAPE= 2

4. Calculate the forecast errors, MAD, MSE, and MAPE for the forecasts you made in Question 2. Use the actual sales data for 2011 given below. Round your answers to the whole number.

Period August September October Actual Sales Forecasts 10,800 11,000 9,700 Errors Absolute Error Error2 Absolute % Error 10,200 November 11,600 December 11,100 MAD= MSE= MAPE=

5. Based on the two methods used to calculate forecasts for TFY, which method produced the best forecast? The moving average method or the exponential smoothing method?

Question 4

Snow International Inc. is founded on October 1 and is preparing inventory worksheet for auditor’s review. Due to bad weather conditions, Snow is forced to close down as of October 17, 20x9, and bad weather continues till November 2, 20x9. Therefore, the last day of Snow operation is October 16, 20x9.   Since Snow is selling a new innovative product and there is no market data, thus Snow can assume that there is no inventory valuation impairment in October. Snow accountant prepares some data below:

20x9 Inventory data (Units in thousands)

Sales data:

Purchase data:

Required:

1. Assuming that perpetual records are kept in dollars, compute the inventory at October 31, using FIFO and LIFO on perpetual system.                                
2. After the bad weather, Snow has to repair major damages in the building, and repair work is completed in December 1, 20x9, and Snow does not operate for the month of November. When the accountant prepares inventory for November 20x9 closing, she finds out that the net realizable value of the single product now was $6.00 per unit, replacement cost is $7.70 per unit, cost and profit per unit together was $0.45. Does Snow report impairment under LIFO and FIFO in November 20x9? Please show calculations.     

Founded in 1964 as Clipper Trucking Co., within two
decades Spirit Airlines was chugging through the skies as
a tiny commercial airline connecting passengers between
Florida and the Midwest. Yet by the 2000s, Spirit was
near failure—a common story in the commercial airline
business—until seasoned aviation executive and merciless
cost-cutter Bill Franke stepped in in 2006 to buy the airline
and then did something remarkable. Franke had honed his
chops cutting costs as CEO of America West Airlines in the
1990s and was an early investor in ultra-low cost Ryan Air.
Despite his detractors, Franke, along with his CEO, Ben
Baldanza, put Spirit on a steadier (if frill-free) fl ight path,
making it not only one of the few post-9/11 success stories,
but also a trend-setter and model in a deeply challenged
industry.
While larger carriers have suff ered billions of dollars in
losses and bankruptcies, Spirit was fl ying high last year with
$289 million in earnings, 40 percent more per plane than any
other domestic airline. Th e company is currently valued at
about $1.63 billion, the same as U.S. Airways Group Inc., which
is about nine times larger in terms of traffi c. Despite its tiny
size—Spirit carries just 1 percent of the nation’s fl iers on its
40-jet fl eet—only two U.S. airlines have fared better: Southwest
(with 692 Boeing jets) and Alaska Air Group Inc. (with
122 aircraft). While many airlines continue to cancel services,
lay off employees, and cut corners to maintain minimal
profi tability, in 2011 Spirit’s revenue soared 37.1 percent over
the previous year. Th e airline also fl ew 15.2 percent more seats
and added multiple routes.
So how did Franke and Baldanza transform a company
once facing bankruptcy into the most profitable airline
in the United States? By doing everything that was once
deemed impossible, yet has since—thanks to Spirit’s
innovative example—become the industry standard. That
means offering the cheapest tickets in the business and
making everything—from water to boarding passes—a
la carte. Spirit was the first U.S. airline to reintroduce
a charge for checked luggage, which has since become
commonplace.
Spirit has found its niche—the traveler who is ultra-budget
conscious and is interested in little more than getting from
A to Z at the cheapest possible price. It’s that simple, and
Spirit doesn’t pretend to embody anything else—not comfort,
not convenience, not service. Spirit’s on-time performance
is among the worst in the industry; its legroom is negligible
at best, and (not surprisingly, considering its bare bones
approach to travel), it has suff ered more than a few PR
disasters in recent years. Th ese include irate, vocal customers
like Jerry Meekins, a 76-year-old Vietnam vet with terminal
cancer, who was denied a refund by Spirit after he was told by
doctors that he had only months to live and couldn’t fl y (and
so couldn’t use his ticket); and a 2010 pilot strike that saw the
airline grounded for 10 days.

Yet Baldanza seems unphased: “We just want to have the
lowest price. Th at drives almost every other decision in the
company: how many seats to have in the airplane, what times
of day to fl y, the kinds of cities we fl y to, and so on.”
With Spirit’s enviable balance sheet, it’s likely that more
airlines will get on board with the nickel-and-diming scheme.
It may be bad news for consumers, but it’s good news to
airlines that are struggling to make a profi t in uncertain
times.

1. Spirit’s number one goals seems to be “the lowest-price airline ticket.” Is this a S.M.A.R.T Goal? Explain.

2. Will this strategic goal continue to be successful for Spirit? Why or Why Not?

3. If you were the CEO of Spirit, what goals would you add to ensure that the company prospers in the long run?

JIT at Arnold Palmer Hospital

Orlando’s Arnold Palmer Hospital, founded in 1989, specializes in treatment of women and children and is renowned for its high- quality rankings (top 10% of 2000 benchmarked hospitals), its labor and delivery volume (more than 14,000 births per year), and its neonatal intensive care unit (one of the highest survival rates in the nation). But quality medical practices and high patient sat- isfaction require costly inventory—some $30 million per year and thousands of SKUs.* With pressure on medical care to manage and reduce costs, Arnold Palmer Hospital has turned toward con- trolling its inventory with just-in-time (JIT) techniques.

Within the hospital, for example, drugs are now distributed at the nursing stations via dispensing machines (almost like vending machines) that electronically track patient usage and post the related charge to each patient. Each night, based on patient demand and prescriptions written by doctors, the dispensing stations are refilled.

To address JIT issues externally, Arnold Palmer Hospital turned to a major distribution partner, McKesson General Medical, which as a first-tier supplier provides the hospital with about one-quarter of all its medical/surgical inventory. McKesson supplies sponges, basins, towels, Mayo stand covers, syringes, and hundreds of other medical/surgical items. To ensure coordinated daily delivery of inventory purchased from McKesson, an account executive has been assigned to the hospital on a full-time basis, as well as two other individuals who address customer service and product issues. The result has been a drop in Central Supply average daily inventory from $400,000 to $114,000 since JIT.

JIT success has also been achieved in the area of custom surgical packs. Custom surgical packs are the sterile coverings, dispos- able plastic trays, gauze, and the like, specialized to each type of surgical procedure. Arnold Palmer Hospital uses 10 different cus- tom packs for various surgical procedures. “Over 50,000 packs are used each year, for a total cost of about $1.5 million,” says George DeLong, head of Supply-Chain Management.

The packs are not only delivered in a JIT manner, but packed that way as well. That is, they are packed in the reverse order they are used so each item comes out of the pack in the sequence it is

*SKU 5 stock keeping unit needed. The packs are bulky, are expensive, and must remain sterile. Reducing the inventory and handling while maintaining an ensured sterile supply for scheduled surgeries presents a challenge to hospitals.

Here is how the supply chain works: Custom packs are assem- bled by a packing company with components supplied primar- ily from manufacturers selected by the hospital, and delivered by McKesson from its local warehouse. Arnold Palmer Hospital works with its own surgical staff (through the Medical Economics Outcome Committee) to identify and standardize the custom packs to reduce the number of custom pack SKUs. With this inte- grated system, pack safety stock inventory has been cut to one day.

The procedure to drive the custom surgical pack JIT system begins with a “pull” from the doctors’ daily surgical schedule. Then, Arnold Palmer Hospital initiates an electronic order to McKesson between 1:00 and 2:00 p.m. daily. At 4:00 a.m. the next day, McKesson delivers the packs. Hospital personnel arrive at 7:00 a.m. and stock the shelves for scheduled surgeries. McKesson then reor- ders from the packing company, which in turn “pulls” necessary inventory for the quantity of packs needed from the manufacturers.

Arnold Palmer Hospital’s JIT system reduces inventory investment, expensive traditional ordering, and bulky storage and supports quality with a sterile delivery.

Discussion Questions** (pls provide different answers from the textbook solutions and from online).

1. When a doctor proposes a new surgical procedure, how do you recommend the SKU for a new custom pack be entered into the hospital’s supply-chain system?