Clean Wash Ltd. manufactures and markets automatic washing machines. Among the hundreds of components which it purchases each year from external suppliers for assembling into the finished articles are drive belts, of which it uses 400,000 units per annum. It is considering converting its purchasing, delivery and stock control of this item to a Just-In-Time (JIT) system. This will raise the number of orders placed but lower the administrative and other costs of placing and receiving orders. If successful, this will provide the model for switching most of its inwards supplies into this system.
Details of current and proposed ordering and carrying costs are given below:
|
Current
|
Proposed
|
|
Ordering cost per order
Purchase cost per item
Inventory holding cost (as a percentage of the purchase cost)
|
Sh.10,000
Sh.25
20%
|
Sh.2,500
Sh.25
20%
|
To implement new arrangements will require a one-off reorganization costs estimated at Sh.140,000 which will be treated as revenue item for tax purposes. The rate of corporation tax is 32.5% and Clean Wash Ltd. can obtain finance at an effective cost of 18%. The life span of the new system is 8 years.
Required
(a) (i) The economic order quantity with current and proposed arrangements.
(ii) New Present Value (NPV) of the new arrangement. Is the new arrangement worthwhile?
(b) Briefly explain the nature and objectives of JIT purchasing arrangements concluded between components users and suppliers.