Assuming that the company will start making the part. a) The economic production quantity b) Total annual inventory holding cost c) Total annual setup cost d) Total annual manufacturing cost e) Total annual holding, setup and manufacturing cost
Managers at ABC, Inc. are reviewing the economic feasibility of manufacturing a part that the company currently purchases from a supplier.
ABC’s financial analysts established a cost of capital of 10% for the use of funds for investments within the company. In addition, over the past year $500,000 was the average investment in the company’s inventory. Accounting information shows that a total of $24,000 was spent on taxes and insurance related to the company’s inventory. In addition, an estimated $9000 was lost due to inventory shrinkage, which included damaged goods as well as pilferage. A remaining $15,000 was spent on warehouse overhead, including utility expenses for heating and lighting.
An analysis of the purchasing operation shows that approximately four hours are required to process and coordinate an order for the part regardless of the quantity ordered. Purchasing salaries average $28 per hour, including employee benefits. In addition, a detailed analysis of 125 orders showed that $2375 was spent on telephone, paper, and postage directly related to the ordering process.
Currently, the company has a contract to purchase the part from a supplier at a cost of $22 per unit. However, over the past few months, the company’s production capacity has been expanded. As a result, excess capacity is now available in certain production departments, and the company is considering the alternative of producing the parts itself.
Forecasted utilization of equipment shows that production capacity will be available for the part being considered. The production capacity is available at the rate of 1000 units per month. Production costs are expected to be $20 per part.
A concern of management is that setup costs will be substantial. The total cost of labor and lost production time is estimated to be $70 per hour, and a full eight-hour shift will be needed to set up the equipment for producing the part.
Managerial Report
Develop a report for management of ABC that will address the question of whether the company should continue to purchase the part from the supplier or begin to produce the part itself. Include the following factors in your report:
- Assuming that the company will start making the part.
a) The economic production quantity
b) Total annual inventory holding cost
c) Total annual setup cost
d) Total annual
e) Total annual holding, setup and manufacturing cost
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