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A Make or Buy Analysis

Managers at Wagner Fabricating Company are reviewing economic feasibility of manufacturing the part which it presently purchases from the supplier. Forecasted annual demand for the project is 3,200 units.

Accounting department at Wagner has established a cost of capital of 14%, for use of funds for investments within the company.  Additionally, over the past year US$600,000 has been average investment within the company’s inventory.  Accounting information shows that a total of US$24,000 was spent on taxes and insurance related to company’s inventory.  In addition, an estimated US$9,000 was lost due to inventory shrinkage, which included damaged goods as well as pilferage. Remaining US$15,000 was spent on warehouse overhead, including utility expense for heating and lighting.

Analysis of the purchasing operation shows that approximately 2 hours are required to process and co-ordinate an order for the part regardless of the quantity ordered. Purchasing salaries average US$28 per hour, including employee benefits.  Also, a detailed analysis of 125 orders showed that US$2,375 was spent on telephone, paper and postage directly related to the ordering process.

Presently, company has the contract to purchase the part from a supplier at a cost of US$18 per unit.  Though, 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 that alternative of producing the parts itself.

A 1-week lead-time is needed to obtain the part from the supplier. An analysis of the demand during the lead-time demonstrates that lead-time demand is approximately normally distributed with a mean of 64 units.  Standard deviation was estimated to be the square root of the mean.  Service level guidelines indicate that the company frowns upon more than 1 stock-out per year.

Forecasted utilisation of equipment demonstrates that production capacity would be existing for the part being considered.  Production capacity is available at the rate of 1,000 units per month, with up to 5 months of production time available.  Management believes that with the 2-week lead-time, schedules could be arranged so that the part could be produced whenever needed. Demand at the time of 2-week lead-time is approximately normally distributed, with mean 128 units and a standard of 20 units.  Production costs are expected to be US$17 per part.

A concern of management is that set-up costs will be significant.  The total cost of labour and lost production time is estimated to be US$50 per hour.  Contractual arrangement and demands of union dictate that the company operates 250 days for the year.  Also, an 8-hour shift will be required to set up the equipment for producing the part

Management has also expressed the wish to take benefits of talk about a quantity discount offer from the supplier.  Indications are that the supplier is willing to give the following discount:

Order Size         Unit Cost
0 - 399              US$18.00
400 - 999           US$17.00
1000 - 1799        US$15.85
1800 and over     US$15.00

Required

1. Develop report for Wagner Fabricating which addresses the problem of whether the company must continue to purchase the part from the supplier or begin to produce the part itself.  The report must address the following:

a. An analysis of the holding costs, including the appropriate annual holding cost rate.

b. An analysis of ordering costs, including the appropriate cost per order from the supplier

c. An analysis of the set up for the production operation

d. A development for the inventory policy for the following two alternatives:

i. Ordering the fixed quantity Q from the supplier

ii. Ordering the fixed quantity Q from in-plant production

e. Report must include the optimal quantity Q*, the number of production runs per year, the cycle time, reorder point, safety stock, expected maximum inventory level, annual cost of the units purchased or manufactured.  You require giving a comparative analysis of the cost of purchasing versus cost of producing, and the optimal quantity under the discount policy.

2. Push and pull systems of inventory management and control require to understood fully, in order to apply their principles efficiently. Discuss, in the context of any manufacturing entity in Jamaica (using appropriate exs, as seen fit).  Note, stay within the following word range (WR): 1200 ≤ x ≤ 1600.

Operation Management, Management Studies

  • Category:- Operation Management
  • Reference No.:- M91334

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