Inventory Case
Case Problem: Make or Buy Analysis
Larsen Fabricating Company is reviewing the economic feasibility of manufacturing a part that it currently purchases from a supplier. Forecasted annual demand for the part is 3200 units. Larsen operates 250 days per year. Larsen's financial analysts have established a cost of capital of 14% for the use of funds for investments within the company. In addition, over the past year $600,000 has been 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, it has been estimated that $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 2 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 the telephone, paper, and postage directly related to the ordering process. A 1-week lead time is required to obtain the part from the supplier. An analysis of demand during the lead time demand is approximately normally distributed with a mean of 64 units and a standard deviation of 10 units. Service level guidelines indicate that one stockout per year is acceptable. Currently the company has a contract to purchase the part from a supplier at a cost of $18 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
Larsen Fabricating Company is reviewing the economic feasibility of manufacturing a part that it currently purchases from a supplier. Forecasted annual demand for the part is 3200 units. Larsen operates 250 days per year. Larsen's financial analysts have established a cost of capital of 14% for the use of funds for investments within the company. In addition, over the past year $600,000 has been 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, it has been estimated that $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 2 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 the telephone, paper, and postage directly related to the ordering process. A 1-week lead time is required to obtain the part from the supplier. An analysis of demand during the lead time demand is approximately normally distributed with a mean of 64 units and a standard deviation of 10 units. Service level guidelines indicate that one stockout per year is acceptable. Currently the company has a contract to purchase the part from a supplier at a cost of $18 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