The financial controller of Mexet plc is reviewing the company's stock management procedures. Stock has gradually increased to 25 per cent of the company's total assets and, with finance costs at 14 per cent per annum, currently costs the company £4.5 million per year, including all ordering and holding costs.
Demand for the company's major product is not subject to seasonal fluctuations. The product requires £6 million of standard semi-finished goods annually which are purchased in equal quantities from three separate suppliers at a cost of £20 per unit. Three suppliers are used to prevent problems that could result from industrial disputes in a single supplier.
Stock costs £2 per unit per year to hold, including insurance costs and financing costs, and each order made costs £100 fixed cost and £0.10 per unit variable cost. There is a lead time of one month between the placing of an order and delivery of the goods. Demand fluctuation for the company's finished products results in the following probability distribution of monthly stock usage.
Usage per month 19400 23 000 25 000 27 000 30 000
Probability 0.10 0.22 0.36 0.20 0.12
The cost per unit of running out of stock is estimated to be £0.4.
(a) Calculate the economic order quantity for the semi-finished goods.
(b) Determine what level of safety stock should be kept for these goods.
(c) Calculate the change in annual stock management costs that would result if the goods were bought from only one supplier. Assume that no quantity discounts are available. (5 marks)
(d) The financial controller feels that JIT (just-in-time) stock management might be useful for the company, but the three suppliers will only agree to this in return for an increase in unit price. Explain the possible advantages and disadvantages of JIT, and briefly discuss whether or not Mexet should introduce it.