Roaring Lion Computer Co outsources the production of motherboards for its compu

Question

Roaring Lion Computer Co outsources the production of motherboards for its computers. It is currently deciding which of two suppliers to use: Alpha or Beta Due to differences in the product failure rates in the two companies, 10% of motherboards purchased from Alpha will be inspected and 30% of motherboards purchased from Beta will be inspected The following data refers to costs associated with Alpha and Beta Alpha 40 18,000 Beta 40 18,000 Number of orders per year Annual motherboards demanded Price per motherboard Ordering cost per order Inspection cost per unit Average inventory level Expected number of stockouts Stockout cost (cost of rush order) per stockout Units returned by customers for replacing motherboards Cost of replacing each motherboard Required annual return on investment Other carrying cost per unit per year $ 90 86 $14 10 300 units 300 units 900 $10 400 $ 21 10% $2.80 2.80 300 40 $ 21 10% Requirements 1. What is the relevant cost of purchasing from Alpha and Beta? 2. What factors other than cost should Roaring Lion consider? ..To begin requirement 1 calculate the relevant cost of purchasing from Alpha and Beta Calculate the relevant cost of purchasing from Alpha and Beta Alpha Beta Purchase costs Ordering costs Inspection costs Required annual return on investment Stockout costs Return costs Other carrying costs Total cost

Explanation / Answer

A Relevant cost of purchasing: (amount in $) Alpha Beta Purchase cost 1,620,000 1,548,000 Ordering cost                        560                    400 Inspection cost                  12,600              37,800 Required annal ROI                163,634           160,444 Stockout cost                    1,500                9,000 Return cost                        840                8,400 Other carrying cost                        840                    840 (this cost is not relevant, as the cost is same in both alternatives) Total cost            1,799,974        1,764,884 As the cost of purchasing from Beta is lesser, the company should procure from Beta. Working Notes: Alpha Beta 1 Annual demand 18000 18000 Price per board 90 86 purchase price total            1,620,000        1,548,000 2 No. of orders per year 40 40 ordering cost /order 14 10 Total ordering costs 560 400 3 Inspection: No. of mother boards inspected 1800 5400 (demand*10% & 30%) inspection cost per unit 7 7 toal inspection cost 12600 37800 4 Stockout cost: No. of stock outs 300 900 Stockout cost cost per unit 5 10 Total stock out cost 1500 9000 5 Cost of returning/replacing: No. of returns 40 400 cost of replacing per board 21 21 Total cost of returning 840 8400 6 Carrying cost: Avg inventory (units) 300 300 carrying cost per unit per year 2.8 2.8 total carrying cost 840 840 7 Annual ROI: Total investment in motherboard costs            1,636,340        1,604,440 (All costs added excluding ROI) Expected ROI % (Cost of capital) 10% 10% Expected ROI $                163,634           160,444 B Other factors to be considered apart from cost: 1 Stock out instances are very high with Beta (3 times more than Alpha's). This will affect the ability of Roaring lion to serve its customers on time. This may inturn lead to loss of customers to competition and hence business. 2 Frequent replacement requests from customers would affect the brand image & goodwill of Roaring lions with customers, as they will start feeling that the company's products are inferior. This will affect the business in the long turn. The above considerations must be paid attention before giving the orders to Beta.

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