In total, the plant produced about 0,000 elevators per year. For each of these,
ID: 469294 • Letter: I
Question
In total, the plant produced about 0,000 elevators per year. For each of these, a variety of components had to be procured from suppliers. The motor was by far the most critical of these components. The same motor was used in every elevator that was produced and it was supplied by Smithfield. Prior to the recent proposal, Smithfield had charged $2.100 per motor. In addition, each time that Johnson placed an order, it had to pay $1,000 for a truck, which could hold up to 210 motors, to drive the motors from the Smithfield plant in Chicago. Currently, Sarah's purchasing manager, Bud McNcally, was having shipments of 120 motors delivered once per week based on a corporate mandate to reduce inventories. Bud was quite proud of the fact that by ordering this often, he had managed to cut his. average on-hand inventory to about 60 units. The Now Offer In September 1999. Smithfield Electric Motors hired a a new marketing manager for its construction products division. The new manager, who had just completed several years working for a major consulting firm, eagerly began implementing new policies. One of these policies was a quantity discount. The discount. The discount worked as follows: Sarah realized that if she look advantage of this opportunity, she would save $150,000 in purchasing costs annually. She also realized that it would have implications for her plant's cash flow, as well as its transportation and inventory costs. In order to better understand the trade-offs, she obtained the following information: Physical Holding Costs The St. Louis plant was attached to a warehouse that was used for storing electric motors and other purchased parts and materials for production. the cost of maintaining the warehouse was about $20,000 per year. Rarely, if ever, was more than about 80% of its capacity used. The warehouse could hold up to 1.000 electric motors if it were completely emptied of other raw materials, which typically occupied about 40 percent of its capacity. Recently, a consultant developed a scheme for allocating the costs of maintaining the warehouse. The allocation mechanism, which was based on the number of square feet that each s.k.u. occupied, resulted in an estimate of $20 as the cost of physically storing an electric motor for one year. However, there was some controversy over whether this allocation of warehouse costs should be used to guide decision making. Other Holding Costs In addition to the costs of physical storage, there were also costs associated with insurance and financing. The cost of insurance for raw materials was approximately 5 percent of the value of inventory, and it was estimated that the cost of capital was about 15 percent. Ordering Costs In addition to the transportation costs that were incurred each time that an order was placed, Bud McNeally told Sarah that they needed to worry about the cuds associated with their EDI software. The software had been updated earlier in the year. It had curt about $20,000 to update the software. Since this was regarded as an expense, instead of an investment, this amount was to be allocated over the anticipated volume of transactions which was approximately 2,000 per year. In addition, the cost of maintaining the software was about $0,000 per year. (Most of the maintenance costs were related to adding suppliers or item identification numbers to the database.) The allocation of the updating and maintenance costs was computed to be $12.50 per transaction. Evaluate the current approach to procurement of motors from Smithfield. estimate the total coot annual associated with procuring and stocking the motors from Smithfield based on their current approach of ordering 120 units at a time? Comment on McNeally's decision to order in quantities of 120 in order to cut the average on hand inventory. Should Sarah take advantage of the new quantity discount? How would doing so affect the plant's total animal cost associated with procuring and stocking electric motors?Explanation / Answer
1). Holding cost per unit per year = $ 20 + 20% of cost price = $ 20 + 20%*2100 = $ 440
Average Cycle stock = 120/2 = 60
Annual stocking (holding) cost = 440*60 = $ 26,400
Ordering cost per order = $ 1000 + $ 12.5 = $ 1012.5
Number of orders per year = 6000 / 120 = 50
Annual procurement (ordering) cost = 1012.5*50 = $ 50,625
Total stocking and procurement cost = 26,400 + 50,625 = $ 77,025
Annual cost of material = 2100*6000 = 12,600,000
Total cost (stocking + procurement + material) = 12,677,025
2). EOQ = (2*Annual Demand*Ordering cost/Holding cost)0.5 = (2*6000*1012.5/440)0.5 = 166
Holding cost = 166/2*440 = 36520
Ordering cost = 6000/166*1012.5 = 36596
Material cost = 2100*6000 = = 12,600,000
Total cost = 12,673,116
This cost is less than Bud’s decision to order in lot of 120 each.
3). If Sarah takes advantage of quantity discount, the total cost will change as below
Order quantity = 200
Unit Cost = 2075
Holding cost = 20 + 20%*2075 = 435
Ordering cost = 1012.5
Total holding cost per year = 435*200/2 = 43,500
Total ordering cost per year = 6000/200*1012.5 = 30,375
Total material cost per year = 2075*6000 = 12,450,000
Total cost = 12,523,875
As we see that the total cost is less than current policy of lot size 120 and EOQ policy of 166, so Sarah should take advantage of the quantity discount and order in lots of 200 each.
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