QA Part A & B

Book Title: eTextbook: An Introduction to Management Science: Quantitative Approaches to Decision Making Chapter 10. Inventory Models Case Problem 1. Wagner Fabricating Company

Case Problem 1. Wagner Fabricating Company

Managers at Wagner Fabricating Company are reviewing the economic

feasibility of manufacturing a part that the company 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.

A one-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.

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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 company’s

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 five months of production time

available. Management believes that with a two-week lead time, schedules can

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

during the two-week lead time is approximately normally distributed, with a

mean of 128 units and a standard deviation of 20 units. Production costs are

expected to be $17 per part.

A concern of management is that setup costs will be substantial. The total cost of

labor and lost production time is estimated to be $50 per hour, and a full eight-

hour shift will be needed to set up the equipment for producing the part.

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?

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