Managers at Wagner Fabricating Company are reviewing the economic feasibility of manufacturing a part that it currently purchases from a supplier. Forecasted annual demand for the part is 3200 units. Wagner operates 250 days per year.

Wagner’s financial analysts established a cost of capital of 14% for the use of funds for investments within the company. In addition, over the past year $600,000 was the average investment in the company’s inventory. Accounting information shows that a total of $24,000 was spent on taxes and insurance related to the company’s inventory. In addition, an estimated $9000 was lost due to inventory shrinkage, which included damaged goods as well as pilferage. A remaining $15,000 was spent on warehouse overhead, including utility expenses for heating and lighting.

An analysis of the purchasing operation shows that approximately two hours are required to process and coordinate an order for the part regardless of the quantity ordered. Purchasing salaries average $28 per hour, including employee benefits. In addition, a detailed analysis of 125 orders showed that $2375 was spent on telephone, paper, and postage directly related to the ordering process.

Managerial Report

Develop a report for management of Wagner Fabricating that will address the question of whether the company should continue to purchase the part from the supplier or begin to produce the part itself. Include the following factors in your report:

1. An analysis of the holding costs, including the appropriate annual holding cost rate

2. An analysis of ordering costs, including the appropriate cost per order from the supplier

3. An analysis of setup costs for the production operation

4. A development of the inventory policy for the following two alternatives:

a. Ordering a fixed quantity Q from the supplier

b. Ordering a fixed quantity Q from in-plant production

5. Include the following in the policies of parts 4(a) and 4(b):

a. Optimal quantity Q*

b. Number of order or production runs per year

c. Cycle time

d. Reorder point

e. Amount of safety stock

f. Expected maximum inventory

g. Average inventory

h. Annual holding cost

i. Annual ordering cost

j. Annual cost of the units purchased or manufactured

k. Total annual cost of the purchase policy and the total annual cost of the production policy

6. Make a recommendation as to whether the company should purchase or manufacture the part. What savings are associated with your recommendation as compared with the other alternative?