Current situation:

To assist with your analysis, Diego asked his cost accountant to summarize some of the key

financial figures relating to inventory:

Carbon steel makes up 85% of RU's inventory value. Because of its strength, it is

necessary to handle the long-term stress put on gym equipment. Annual requirements

for carbon steel are 76,800 kilograms. It is purchased by the kilogram at an average

cost of $0.71 per kg.

Carbon steel is ordered on a monthly basis from Majuba Steel Inc., a local importer of

steel from overseas. RU works with a purchasing agent who contracts with RU to order

in the steel from Majuba. The agent, who works away from RU's office, writes up the

order on a paper document, faxes it to the supplier and follows up via phone to ensure

the order is filled. She charges $390 per order. This is the only order cost incurred.

Annual costs of warehouse leasing, insurance, utilities, and management are $8.80 per

kilogram of carbon steel.

RU's opportunity cost is 12%

Proposed JIT:

Diego is also considering implementing a just-in-time (JIT) manufacturing system to reduce

RU's costs and be responsive to demand. He has already consulted with an industrial

engineer to learn more about how to rearrange the shop floor to create a lean manufacturing

environment. Costs and resulting benefits of implementing JIT (excluding inventory carrying

and ordering costs) are as follows:

One-time cost to rearrange the shop floor to create manufacturing workstations is

$440,000

Retrain existing workforce for the JIT required skills is $60,000

Anticipated defect reduction is 30%. Currently there is a cost of quality defect

assessment listed as $150,000 per year. This is considered to be an internal failure

cost.

RU manufactures its products using a batch process. The setup time for each of the

batches will be reduced by 40% under a JIT system. Current annual setup costs are

$350,000.

A 20% premium on production supplies will be charged as supplies will be delivered

on a more frequent schedule. Currently production supplies are $520,000 per year.

Required:

a. CURRENT SITUATION: To begin this analysis, you decide to assess the current

situation as it relates to RU's ordering practices and carrying costs. Your initial thought

is the company may be able to optimize its order and carrying costs using existing

practices.

i. Given current ordering practices, what is the total annual relevant cost of

ordering and carrying inventory. (4 marks)

ii. Using Economic Order Quantity, what is the optimal order size for carbon steel

(in kilograms) RU should use to minimize total annual order and carrying costs.

(2 marks)

iii. Calculate the savings incurred in ordering using the order quantity calculated in

part (ii) (2 marks)

b. PROPOSED JIT. Diego informs you that the industrial engineer hired to assess RU's

manufacturing system, suggests total inventory carrying costs can be reduced by 50%

if inventory is ordered in quantities of 760 kilograms.

i. Explain to Diego the effect this will have on total inventory costs (carrying and

ordering) and provide a potential solution to reduce total inventory costs.

(Calculations are not required). (3 marks)

ii. Determine whether it is in the best interest of the RU Fitness Company to install a

JIT manufacturing system.

Focus on:

Relevant manufacturing costs/savings (exclude inventory order and carrying

costs) and the ability to show a return on the cost. (Remember to identify annual

and onetime costs/savings)

The advantage and disadvantage of JIT for RU (minimum 1 each)

Show all calculations and provide a response to Diego which includes pertinent figures

from your calculations. (5 marks)