A MAKE OR BUY ANALYSIS:
Figi Fabricating Company is reviewing the economic feasibility of manufacturing a part which it presently purchases from a supplier. Forecasted annual demand for the part is 3200 units. Figi operates 250 days per year (50 weeks @ 5 days per week).
Figi's financial analysts have established a cost of capital of 14% on the use of funds for investments in the company. Additionally, accounting information exhibits that a total of 4% of costs were spent on taxes and insurance associated to the company's inventory. This has been estimated that the other 1.5% was lost due to inventory shrinkage that included damaged goods and also pilferage. Lastly, 2.5% was spent on warehouse overhead, comprising utility expenses for heating and lighting.
An analysis of purchasing operation shows that around two hours are needed to process and coordinate an order for the part regardless of the quantity ordered. Purchasing salaries average $28 per hour, comprising employee benefits. Additionally, a detailed analysis of 125 orders showed that $2375 was spent on telephone, paper and postage directly associated to the ordering process.
Presently the company has a contract to purchase the part from a supplier at a cost of $18 per unit. Though, over the past few months, the company's production capacity has been expanded. As a result, surplus 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 the production capacity will be accessible for the part being considered. The production capacity is available at the rate of 250 units per week. This is felt that with a short lead-time, schedules can be arranged and hence the part can be produced whenever required. Production costs are expected to be $17 per part.
The concern of management is that setup costs will be important. The total cost of labor and lost production time is estimated to be $50 per hour, and it will take a full 8-hour shift to set up the equipment for producing the part.
Requirements:
Make a one-page report for Figi Fabricating that will address the question of whether the company must continue to purchase the part from the supplier or start to produce the part itself. Include the given factors in your report:
Question 1: Analysis of holding cost, ordering cost (whenever ordering from supplier) and set-up cost (whenever producing the part).
Question 2: Make an inventory policy (how many to order and how often) for the given two alternatives (i) ordering a fixed quantity Q from the supplier or (ii) ordering a fixed quantity Q from in-plant production. Be sure to comprise the (a) Optimal quantity Q* and (b) the total annual cost for each option.
Question 3: Make a recommendation as to whether the company must purchase or manufacture the part. What is the savings associated with your recommendation as compared with the other alternative? Besides the differences in cost, what other factors require to be considered?
Question 4: Sensitivity Analysis: Would the decision change if production costs were raised by $0.50 per part (now the production cost would be $17.50)? If so, how?
Please show all computations. You should use the Equation writer in Microsoft Word on the Insert Ribbon, Symbols group.