Managers at PowerFlex 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.

PowerFlex operates 250 days per year.

PowerFlexs financial analysts have 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 has been the average

investment in the companys Inventory. Accounting information shows that a total of $24,000 was

spent on taxes and insurance related to the companys inventory. In addition, an estimated $9,000

was lost due to inventory shrinkage, which included damaged goods as well as pilferage. A

remaining $15,000 was spent on warehouse overheads, including utility expenses for heating and

lighting.

An analysis of the purchasing operation shows that approximately 2 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 $2,375 was spent on telephone, paper and postage directly related to the ordering process.

A 1-week lead time is required to obtain the part from the supplier. An analysis of demand during

the lead time shows it is approximately normally distributed with a mean of 64 units and a

standard deviation of 10 units. Service level guidelines indicate that one stock out per year is

acceptable.

Currently, the company has a contract to purchase the part from a supplier at a cost of $18 per unit.

However, over the past few months, the companys production capacity has been expanded. As a

result, excess 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 production capacity will be available for the part

being considered. The production capacity is available at the rate of 1000 units per month, with up

to 5 months of production time available. Management believes that with a 2-week lead time,

schedules can be arranged so that the part can be produced whenever needed. The demand during

the 2-week time lead time is approximately normally distributed, with a mean of 128 units and a

standard deviation of 20 units. Product costs are expected to be $17 per part.

A concern of management is that setup costs will be significant. The total cost of labour and lost

production time is estimated to be $50 per hour, and a full-8-hour shift will be needed to set up the

equipment for producing the part.

Managerial Report

Develop a report for management of PowerFlex Company 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. Your report is developed by answering the following questions:

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

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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

Covering the following elements:

(i) Economic order quantity (EOQ)

(ii) Number of orders or production runs per year.

(iii) Cycle time

(iv) Reorder point

(v) Amount of safety stock

(vi) Expected maximum inventory

(vii) Average inventory.

(viii) Annual holding cost

(ix) Annual ordering cost

(x) Annual cost of the units purchase or manufactured.

(xi) Total annual cost of the purchase policy and the total annual cost of the

production policy.

5. 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?