The Brazilian firm, Eletrico, is a supplier of electrical components ´ such as actuator levers and mechanisms that are used in the production of circuit breakers. One of Eletrico’s major customers is Nikola, a multinational manufacturer of electrical equipment, including circuit breakers.Eletrico is a relatively small business, and like other small and medium-sized ´ companies heavily on short-term loans from banks to support its operations because obtaining equity financing is a significant challenge. The average interest rates that banks charge to small businesses in Brazil is approximately 40%, which is extremely high compared to the rates available to businesses in many other developed countries around the world. Coupled with the other components of inventory holding cost such as storage and obsolescence, the high interest rate has led Eletrico to use an annual ´ holding cost rate of 55% in determining its inventory stocking levels. One of Eletrico’s most popular products is its actuator mechanism that is specially designed for the circuit breakers that Nikola produces in its factory located in Praia Grande, Brazil. Eletrico manufactures the mechanisms on an assembly line at ´ its nearby facility in Santos, Brazil. The assembly line can produce the mechanisms at a rate of 9,000 per week. Nikola’s production schedule for its circuit breakers is relatively level at a rate of 20,000 per month; the factory operates over a 50-week year. Each actuator mechanism costs Eletrico 32 Brazilian reals to produce, and ´ each production batch has a fixed setup cost of 1,000 reals.
A) Determine Eletrico’s optimal production batch size and its minimal total annual relevant cost.
B) The extremely high interest rate on its short-term bank loans is preventing Eletrico from consistently upgrading its production technology to the newest standards. Nikola is worried that Eletrico’s older technology will not be able ´ to keep up with its future technical needs, but it is committed to working with Eletrico in the future because the assembly line was purposely located close to Nikola’s facility. Nikola benefits significantly from the short lead time for deliveries from Eletrico and worries that it is not influential enough to entice another ´ supplier to co-locate close to Praia Grande. The purchasing manager at Nikola suggests to the VP of Sales at Eletrico that it may be beneficial to both companies for Nikola to offer short-term financing to Eletrico at a much more competitive interest rate. This would allow Nikola to ´ finance its raw material purchases and production operations while freeing up its existing capital for technology upgrades. Eletrico’s production manager believes ´ that the loan from Nikola would allow it to reduce its annual holding cost rate to 23% for inventory management purposes. Estimate the annual savings in inventory costs that Eletrico could realize by having access to the cheaper source of short-term financing from Nikola.