Innovative Inventory and Production Management Techniques

Chapter 16
Innovative Inventory and Production Management Techniques
Questions
1. The important relationships in the value chain that can be
exploited are (1) between the company and its upstream supplier
and (2) between the company and its downstream customer. It is
at the interfaces of these relationships where real
opportunities for improvements exist. By building improved
cooperation, communication, and integration, the entities
within the value chain can treat each other as extensions of
themselves. In so doing, they can enjoy gains in quality,
throughput, and cost efficiency. Nonvalueadded activities
can be reduced or eliminated and performance of valueadded
activities can be enhanced. Shared expertise and problem
solving can be very beneficial. Products and services can be
provided faster and with fewer defects, and activities can be
performed more effectively and reliably with fewer deficiencies
and less redundancy.
2. The three costs are costs of ordering, purchasing, and carrying
inventory. These costs are presented in Exhibit 161 with
examples.
3. A push system is a production control system in which work
centers produce inventory in excess of current needs because of
lead time or economic production/order quantity requirements.
A pull system of production control is one in which parts
are delivered/produced only as needed by the work center for
which they are intended. Theoretically, there are no stockrooms
where work centers "push" completed parts in excess of the
current needs of recipient work centers.
4. Incremental variable costs associated with preparing,
receiving, and paying for an order are called ordering costs
and include the cost of forms and a variety of clerical costs.
In manufacturing companies, ordering costs are incurred for raw
material purchases. However, if the company intends to produce
rather than order a part, direct and indirect setup costs
(instead of ordering costs) are created as equipment is readied
for each new production run. Therefore, setup costs are the
conceptual counterpart of ordering costs when parts are to be
made rather than purchased.
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5. Advances in information technology have greatly improved the
efficiency and effectiveness of purchasing. Bar coding and
electronic data interchange (EDI) are expected to significantly
reduce procurement costs. An extension of EDI is vendor
managed inventory (VMI), a streamlined system of inventory
acquisition and management. A supplier is empowered to
frequently monitor EDI inventory levels and provide its
customer company a proposed eorder and subsequent shipment.
On electronic acceptance, a funds transfer from the buyer’s
bank is made when the goods are received. Finally, the process
of conducting business transactions over the Internet, known as
ecommerce, has made possible the use of procurement cards (p
cards). These are given to selected employees as a means of
securing greater control over spending and eliminating the
paperbased purchase authorization process.
6. A stockout occurs when a firm runs out of an inventory item.
Such an item could either be finished goods inventory or a
component material.
A company can estimate the cost of a stockout by
estimating
* lost customer goodwill,
* lost contribution margin, and
* additional ordering and shipping costs on special orders.
A manufacturer could also estimate additional setup costs
caused by having to stop the production process and restart it.
7. Companies must be aware of where their products are in their
life cycles, because in addition to the sales effects, the
lifecycle stage may have a tremendous impact on costs and
profits. Managing production activities and costs requires an
understanding of product life cycles in order to effectively
and efficiently engage in production planning, controlling,
problem solving, and performance evaluation.
8. The five stages are development, introduction, growth, maturity
and decline. Each stage is important because it has an
important impact on production costs. The types of costs
incurred vary from stage to stage and effective cost management
must be responsive to how costs are changing as the life cycle
progresses.
9. Costs, sales, and profits change for several reasons. For
example, costs change because of the timing of activities and
volume. In the early stages, costs are being incurred to
develop the product and production processes. In later stages,
production costs are the largest cost component. Sales change
mostly because of changes in customer demand. In the early
stages, sales volume is nil or low. In the middle stages,
volume is high and in the later stages volume stabilizes and
then drops. Secondarily, sales change because of perunit price
changes. Profit changes with the changes in costs and sales.
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10. Target costing is a method of determining what the cost of a
product should be by subtracting desired profit from the
estimated selling price. Once a product's total lifecycle
costs are projected, they can be compared to the target cost to
determine whether adjustments to the product design and
manufacturing process are necessary before product engineers
release the final design and specifications.
11. Target costing requires that profitability be viewed on a long
term basis. The consideration of target cost can impact future
opportunities to reduce costs. The desired target cost may not
be attainable at the start of production, but because learning
curve activities and design for manufacturability have been
considered up front, the target cost should be reachable within
a reasonable time.
12. The big factor is the amount of cost that is incurred to launch
a new product. If the cost to develop and launch a new product
is very large, much research must precede the introduction of a
product to ensure its success. However, if the cost to
introduce a new product is relatively low, a company can rely
on the market to determine which products will be successful.
Products that are not well received by the market can simply be
discontinued.
13. A cost table provides information about the costs of materials,
labor, and production processes. A cost table is useful in the
design of a product because, given alternative materials and
conversion operations, the cost table will facilitate
determining how product cost is affected by alternative product
and process designs.
14. A major distinction between kaizen costing and target costing
is seen in the lifecycle stages in which each is used. Kaizen
costing is used to reduce the cost of products in later stages
of the product life cycle. Target costing is applied in the
product development/design stage.
15. A substitute good (service) is a product (service) that could
be used in lieu of using another product (service). For
example, public bus service could be a substitute for private
taxi service. If the price of travel by taxi rises, riders may
switch to use of bus services to avoid paying the higher taxi
fees.
16. Research and development costs are treated as product costs of
lifecycle costing, whereas they are expensed as period costs
for financial accounting. Treating R&D as product costs gives
a more accurate and complete picture of costs relevant to the
product over its life cycle.
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17. Primary goals of JIT are
* elimination of any process that does not add value to
the product;
* continuous improvement of production efficiency; and
* reduction of total cost of production rather than merely
the cost of purchasing.
JIT attempts to achieve these goals by working to
* eliminate the acquisition/production of inventories in
excess of current needs;
* reduce lead/setup times; and
* minimize product defects.
18. The following changes are needed to effectively implement JIT
in a production environment:
* Selection of a vendor should consider the following items
in addition to the invoice prices:
consistent quality of materials/parts to minimize product
defects;
reliable delivery schedules with short lead times to
allow for maintaining little or no inventory and for
flexibility and speed in setting up production runs;
maintaining longterm relationships with fewer vendors to
improve communications, ensure quality and service, obtain
quantity discounts, and reduce operating costs;
obtaining suppliers who are close to the plant to reduce
lead times and shipping costs.
* Small quantities should be ordered to minimize inventory
carrying costs.
* Product components and tools should be standardized to
lower costs and increase production efficiency.
* The number of product components should be minimized to
lower costs and increase production efficiency.
* Products should be carefully designed to reduce subsequent
change orders.
* Setup times should be shortened to allow for quicker, more
flexible production.
* Production workers are used to continually ensure quality
control in order to reduce costs and approach zero
defects.
* The plant layout should be designed in a manner that is
conducive to the flow of goods and organization of workers
in order to minimize cycle time from material input to
finished product.
* Employee suggestions for improving production should be
sought; these individuals often have a wealth of
information that goes untapped.
* Utilize multiprocess handling to improve worker
flexibility and interest.
JIT is a pull system because products are only produced when
demanded.
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19. One aspect of JIT (being located near vendors) is more
difficult in the United States because the area is much larger
and vendors might be located in a completely different
geographical section of the country. Another reason for less
effective implementation is the differing attitudes between
Japanese and American workers toward their jobs and between
Japanese and American employers toward their employees.
20. Since JIT represents a philosophy of how to do things rather
than how to produce things, many aspects of JIT can be used by
nonmanufacturers. The following elements from solution 18 can
be adopted by nonmanufacturers in relation to their purchasing
techniques and employee base:
* Selection of a vendor should consider the following items
in addition to the invoice prices:
reliable delivery schedules with short lead times to
allow for maintaining little or no inventory and for
flexibility and speed in meeting customer needs;
maintaining longterm relationships with fewer vendors to
improve communications, ensure quality and service, obtain
quantity discounts, and reduce operating costs;
obtaining suppliers that are close to the company to
reduce lead times and shipping costs.
* Small quantities should be ordered to minimize inventory
carrying costs.
* Workers are trained to continually ensure quality control
to reduce costs and approach zero errors.
* The workspace layout should be designed in a manner that
is conducive to the flow of goods and organization of
workers.
* Employee suggestions for improving operations should be
sought; these individuals often have a wealth of
information that goes untapped.
* Utilize job enhancement to improve worker flexibility and
interest.
21. In a lightsout factory, all production is accomplished by an
integrated system of machines. The only involvement of workers
is to monitor and maintain the machines. The term "lightsout"
is simply a metaphor for an environment where one can simply
close the factory doors, turn out the lights, and let the
tireless machines produce.
22. In an FMS, each employee is charged with operating or
overseeing several machines. Although the automation requires
fewer workers than traditional production systems, FMS requires
its workers to have more training than those in a traditional
environment. Also, the employees need to be given the
authority and responsibility to make decisions because the
environment is too fast paced for people "off the floor" to
make certain production decisions.
23. The primary areas in which implementation of a JIT system will
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impact the cost accounting system are as follows:
* Variance analysis should be made sooner in the production
process and variances should be smaller because of
continual monitoring of production.
* A new inventory account RIP (raw and in process) will
combine the two traditional categories of raw material and
work in process because few or no materials will be
stored.
∙23 Because more costs can be traced directly to their related
output, fewer costs must be allocated to products. This
improves the usefulness of measures for cost control and
performance evaluation.
Backflush costing is used because it is a less expensive
accounting technique than those used in traditional
production environments. It is justified on the basis that,
at any point in time, inventory is relatively small compared
to the amount of goods that have been completed and sold.
Thus, on a costbenefit basis, small inventory levels do not
justify more expensive continuous costtracking systems.
24. The theory of constraints states that production
cannot take place at a rate faster than the slowest machine
or person in the process. The theory of constraints can be
used in either a manufacturing or service firm to focus
management's attention on the elimination of the bottlenecks
so that the best use of existing capacity can be made.
25. Quality control inspections should be placed in front
of bottlenecks so that the limited time of the constraint
won't be wasted processing defective units.
26. Total ordering cost declines as order size increases.
Carrying costs increase, in total, as order size increases.
At some point the two costs are equal and it is at this point
that the EOQ point is located. To the right of this point,
total carrying costs exceed total ordering costs.

27. EOQ is the optimal size of an order that is expected
to minimize the total costs of ordering and carrying
inventory. Order point is the level of inventory on hand that
triggers a placement of an order for additional units. Thus,
once the order point is reached, the economic order quantity
should be ordered.
28. Safety stock is the basic quantity (or cushion) of
inventory kept on hand in the event of fluctuating usage or
unusual delays in lead time. It is necessary because of the
uncertainties associated with the rate of usage and the lead
time between placing and receiving an order.
29. Pareto inventory analyses requires that all inventory
items be placed into one of three classes: A, B, or C. The
three categories are distinguished from one another by their
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costtovolume ratio. Highvalue, lowvolume items are
placed in the A category; at the other extreme, lowvalue,
highvolume items are placed in the C category. All other
items are placed in category B. A redline system or a two
bin system is frequently used to control inventory levels of
C items.
30. Inventory is one of many investments made by an
organization and should be expected to earn the same rate of
return as other investments. The cost of capital is
considered to be an indication of a reasonable rate of return
for an organization and represents an opportunity cost of
holding inventory.
31. Inspection of the two formulas (economic production
runs and economic order quantity) shows the many
similarities; the main difference is that, in the EPR
formula, the terms are redefined as production costs rather
than purchasing costs.
Q = annual quantity produced rather than purchased
S = cost of setting up rather than placing an order
C = cost of carrying one unit in stock for one year and
is the same in either formula
Use of the EOQ formula will help Joe minimize his costs of
ordering and carrying if he has a reasonable idea of how many
VCRs to order in total for the year.
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Exercises
32. a. 5
b. 3
c. 8
d. 6
e. 11
f. 7
g. 12
h. 10
i. 2
j. 9
k. 4
l. 1
33. 1. O
2. O
3. O
4. N/A (Purch.)
5. N
6. O
7. N/A (Purch.)
8. C
9. O
10. O
11. N
12. C
13. N/A (Purch.)
14. C
15. C
16. C
17. N
18. C
34. Storage $0.06

Handling 0.04
Insurance 0.02
Opp. cost 0.43
Carrying cost $0.55
(Production labor costs are omitted.)
35. Lifecycle revenue:
Year 1 18,000 × $9 $ 162,000
Year 2 38,000 × 8 304,000
Year 3 70,000 × 6 420,000
Year 4 30,000 × 5 150,000
Total 156,000 $1,036,000
Required profit 156,000 × $1.50 (234,000)
Total target cost $ 802,000
Target cost per unit: $802,000 ÷ 156,000 = $5.14
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36. a.
Lifecycle revenues
Year 1 4,000 × $250 $ 1,000,000
Year 2 3,600 × $250 900,000
Year 3 4,700 × $250 1,175,000
Year 4 5,000 × $175 875,000
Year 5 1,500 × $175 262,500
Totals 18,800 $ 4,212,500
Variable selling costs (18,800 × $30) (564,000)
Fixed selling and administrative (1,750,000)
Required profit ($4,212,500 × 0.20) (842,500)
Target manufacturing cost $ 1,056,000
Target manufacturing cost per unit $ 56.17
b. Total target manufacturing cost
$1,056,000
Year 1 mfg. cost (4,000 × $65)
(260,000)
Total target manufacturing cost $
796,000
Target unit mfg. cost ($796,000 ¸ 14,800)
$53.78
c. The company’s engineers could redesign the
product to make it less costly to produce by lowering
both material and conversion costs or redesign the
process to reduce conversion costs. Also, they could
use kaizen techniques, which could lower costs after
production has started.
37. The student’s memo should address the following
issues:
Target cost = $175 10 = $165. Given that the target
cost is $165 and the anticipated actual firstyear cost is
$180, it is apparent that it will be impossible to realize
the required profit of $10 per unit unless changes are made.
There are two major courses of action. First, management
should ask the product engineers to review product design and
specifications with the purpose of reducing expected average
total lifecycle cost to the required $165 target cost.
Failing success in this endeavor, management could consider
launching the product with the objective of achieving long
term price reductions through kaizen costing techniques. If
management is pessimistic about the company’s ability to
achieve the required longterm reductions in cost, the plans
for the product should be abandoned.
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38. a. Material usage variance:
Actual cost of materials this month:
(A) 22,000 lbs. × $2.25 per lb. = $49,500
(B) 20,500 lbs. × $3.40 per lb. = 69,700 $119,200
Current materials standard:
(A) 3,000 × 7 × $2.25 per lb. = $47,250
(B) 3,000 × 7 × $3.40 per lb. = 71,400 118,650
Material usage variance $ 550 U
Annual materials standard:
(A) 3,000 × 6 × $2.25 per lb. = $40,500
(B) 3,000 × 8 × $3.40 per lb. = 81,600 $122,100
Current standard 118,650
ENC variance $ 3,450 F
b. The effect of the engineering change was to
change the mix of material inputs to favor the less
expensive material, A. For July, this engineering change
generated cost savings of $3,450.
39. a. SP × AQ SP × SQ

$0.10 × 250,000 = $25,000 $0.10 × 240,000 = $24,000
$0.25 × 108,000 = 27,000 $0.25 × 120,000 = 30,000
$52,000 $54,000
| |
| $2,000 F |
Material Usage Variance
(Material X, $1,000 U; Material Y, $3,000 F)
b. Current SP × SQ Annual SP × SQ
$0.10 × 240,000 = $24,000 $0.10 × 300,000 = $30,000
$0.25 × 120,000 = 30,000 $0.25 × 60,000 = 15,000
$54,000 $45,000
| |
| $9,000 U |
ENC Variance
(Material X, $6,000 F; Material Y, $15,000 U)
c. The engineering change could have been to
increase the quality or nutritional content of the cat
food. This may have been done in response to
competitors' actions or to enter a new segment of the
cat food market.
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40. a. 1. Raw and In Process Inventory
320,000
Accounts payable
320,000
2. Conversion costs 708,000
Various
708,000
3. Raw and In Process Inventory 704,000
Conversion costs
704,000
4. Finished Goods Inventory 1,024,000
Raw and In Process Inventory
1,024,000
5. Cost of Goods Sold 1,011,200
Finished Goods Inventory
1,011,200
6. Cost of Goods Sold 4,000
Conversion costs
4,000
7. Accounts receivable 1,580,000
Sales
1,580,000
Alternatively, the following journal entries
could be used:
Finished Goods Inventory 12,800
Cost of Goods Sold 1,011,200
Accounts payable
320,000
Conversion costs
704,000
Cost of Goods Sold 4,000
Conversion costs
4,000
Accounts receivable 1,580,000
Sales
1,580,000
b.

Raw and In Process Finished Goods
1. 320,000 |4. 1,024,000 4. 1,024,000 |5.
1,011,200

3. 704,000

| Bal 12,800 |

Bal 0 | |
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| |

Cost of Goods Sold Conversion
Costs
5. 1,011,200 | 2. 708,000 |
3. 704,000

6. 4,000

|

|
6. 4,000
Bal 1,015,200 | Bal 0 |

Accounts payable Various
accounts
| 1. 320,000 | 2.
708,000

Sales Accounts
receivable
| 7. 1,580,000 7. 1,580,000 |
c. The remaining balance in finished goods =
($1,024,000 ¸ 16,000) × 200 = $12,800
41. No, Office Provisions did not complete the 180 units by
5:00
PM.
Time of Afternoon Output

12 2
3 3
4 4
5 Total
Dept. 1 44 40 49 47 180
Dept. 2 44 40 45 45 174
Dept. 2
Backlog 0 0 4 2
Cumulative
Dept. 2
Backlog 0 0 4 6 6*
* The robot can be counted on to finish 45 units per hour.
Although Dept. 1 averaged 45 units per hour it was late
getting 6 units to Dept. 2 in the last two hours. Since the
robot was constrained to 45 units per hour, it could not
handle the extra 4 units given it between 3:00 and 4:00 and
the extra 2 units given it between 4:00 and 5:00.
42. $14,700; at the EOQ, the total annual carrying costs
will equal the total annual ordering costs.
43. EOQ (Wonder Cream) = SQRT (2QO ÷ C)

= SQRT [(2 × 2,000 × 4.50) ÷ 2.00]
= SQRT (9,000)
= 94.9 or 95
EOQ (SkinsoBright) = SQRT [2 × 1,000 × 6.25) ÷ 1.45]
= SQRT (8,621)
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= 92.85 or 93
EOQ (Fresh & Sweet) = SQRT [(2 × 900 × 3.70) ÷ 1.25]
= SQRT (5,328)
= 72.99 or 73
44. EOQ = SQRT(2QO ÷ C)
(EOQ)2 = 2QO ÷ C
(C × EOQ2) ÷ (2 × O) = Q
Q = (0.65 × (78)2) ÷ (2 × 6.08)
= 3954.6 ÷ 12.16
= 325.21, or 325 units
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45. a. EPR = SQRT(2QS ÷ C)
= SQRT[(2 × 2,500 × 200) ÷ 5]
= SQRT(200,000)
= 447.21, or 447 units
Number of runs = 2,500 ÷ 447 = 5.59 runs
5.59 runs × $200 per run = $1,118 total setup cost
$5 × (447 ÷ 2) = $1,118 total carrying cost
Total cost = $1,118 + $1,118 = $2,236
b. EPR = SQRT[(2 × 2,500 × 40) ÷ 20]
= SQRT(10,000)
= 100 units
Number of runs = 2,500 ÷ 100 units = 25 runs
25 runs × $40 = $1,000 setup cost
Carrying cost = $20 × (100 ÷ 2) = $1,000
Total cost = $1,000 + $1,000 = $2,000
46. EPR = SQRT(2QS ÷ C)
= SQRT[(2 × 1,600 × $400) ÷ $2.00]
= SQRT(640,000)
= 800 units
= SQRT[(2 × 10,000 × $25) ÷ $2]
= SQRT(250,000)
= 500 units
b. Annual setup costs (10,000 ¸ 500) × $25 = $ 500
Annual carrying costs (500 ¸ 2) × $2 = 500
Total annual costs $1,000
48. a. EOQ = SQRT(2QS ÷ C)
= SQRT[(2 × 9,000 × $15) ÷ $.25]
= SQRT(1,080,000)
= 1039.23, or 1,039 units
b. 9,000 ÷ 1,039 = 8.66, or 9 orders per year
c. 12 months ÷ 9 orders = 1 order every 1.33 months
49. a. The controller would want to isolate just
the variable costs those costs that vary with the
number of orders processed. In this case, the relevant
costs would include the $0.30 of department supplies,
and $3.02 for phone expense.
b. Similar to the ordering costs, the controller
would only want to include those costs that vary with
the number of units stored. The variable costs include
the $0.05 for inventory insurance and $0.07 for
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obsolescence.
50. a. YEAR
1 2 3 4
Revenue $250,000 $600,000 $805,000 $1,050,000
Less costs:
DM and DL 105,000 262,500 367,500 525,000
VOH 25,000 62,500 87,500 125,000
FOH* 175,000 175,000 175,000 175,000
Gross M. $(55,000) $100,000 $175,000 $ 225,000
GM % (22%) 16.67% 21.74% 21.43%
Cost per unit $3.05 $2.00 $1.80 $1.65
YEAR
5 6 7 8
Revenue $1,200,000 $900,000 $380,000 $247,000
Less costs:
DM and DL 693,000 519,750 231,000 150,150
VOH 150,000 112,500 50,000 32,500
FOH 175,000 175,000 175,000 175,000
Gross M. $ 182,000 $ 92,750 $(76,000) ($110,650)
GM% 15.17% 10.31% (20%) (44.80%)
Cost per unit $1.70 $1.79 $2.28 $2.75
*FOH includes the $600,000 spent on R&D, allocated at $75,000
for each year of product life.
b.
Total Revenues $5,432,000
Less costs:
DM and DL 2,853,900
VOH 645,000
FOH 800,000
Research and development 600,000
Lifetime gross margin $ 533,100, or 9.81%
c. The analysis in part (a) measures income solely
on an annual basis and considers R&D as a product cost
allocated at a rate of $75,000 per year. The analysis
in part (b) regards the R&D costs as a product cost but
does not allocate the cost of overtime. Part (a)
analysis makes a product appear upon introduction, if
significant costs were incurred that year for its
development, to be an unprofitable item an analysis
that hardly makes the introduction of new products
appear worthwhile.
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51. a. D
b. U
c. T
d. D,T
e. T
f. T
g. D
h. T
i. T
j. D, T
52. a. (1) Raw and In Process 24,904,000

Material Price variance 480
Accounts Payable 24,904,480
(2) Conversion costs 3,000,000

Accum. depreciation 600,000
Cash 2,200,000
Accounts. Payable 200,000
(3) Raw and In Process 2,912,000

Conversion cost 2,912,000
(20,800 × $140)
(4) No entry
(5) Conversion costs 14,442,000

Acc. dep. 4,000,000
Cash 9,325,000
Acc. pay. 1,117,000
(6) Raw and In Process 14,448,000

Conversion costs 14,448,000
(103,200 × $140)
b. (103,200 rolls × 0.4) = 41,280 yd.; 41,280 × $2 = $82,560
increase
c. Material Quantity Engineering
Change Variance 82,560
Raw and In Process 82,560
d. 103,200 × 5/240 × $140 = $301,000 saved
e. Conversion costs 301,000
Machine Hrs. Eng. Change Variance 301,000
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f. Actual conversion costs
($3,000,000 + $14,442,000) $17,442,000
Machine hrs. engineering change 301,000
Revised conversion costs $17,743,000
Applied conversion costs
($2,912,000 + $14,448,000) 17,360,000
Underapplied $ 383,000
g. Increase in material cost per roll (0.4 × $2.00) $ 0.80
Decrease in conv. cost per roll (5/60 × $35) (2.92)
Net decrease in cost per roll $(2.12)
Yes, the changes are cost beneficial.
53. a. EOQ = SQRT[(2 × 14,000 × 16.00) ÷ 0.50]
= SQRT(896,000)
= 946.57, or 947 pounds
b. average daily usage = 14,000 ÷ 365 = 38.36 lbs.
order point = [38.36 × (12 + 7)] = 728.84 lbs.
= SQRT[(2 × 30,000 × $50) ÷ $0.25]
= SQRT(12,000,000)
= 3,464.10, or 3,464 pounds
b. Number of runs = 30,000 ÷ 3,464 = 8.66, or 9 runs
c. EOQ (seed) = SQRT(2QO ÷ C)
= SQRT[(2 × 30,000 × 2 × 2 × $4.25) ÷ $0.01]
= SQRT(102,000,000)
= 10,099.51, or 10,100 seeds
EOQ (fertilizer) = SQRT[(2 × 30,000 × 0.25 × $8.80) ÷ $0.05]
= SQRT(2,640,000)
= 1,624.81, or 1,625 pounds of fertilizer
d. Seed orders = (30,000 × 2 × 2) ÷ 10,100 = 11.88, or
12 orders
Fertilizer orders = (30,000 × 0.25) ÷ 1,625 = 4.62, or
5 orders
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e. Total cost:
Average inventory (onions): 3,464 ÷ 2 = 1,732 lbs.
(seeds) : 10,100 ÷ 2 = 5,050 seeds
(fertilizer) : 1,625 ÷ 2 = 812.5 lbs.
Carrying costs:
Onions: 1,732 × $0.25 = $433.00
Seeds: 5,050 × $0.01 = 50.50
Fertilizer: 812.50 × $0.05 = 40.63 $ 524.13
Total
Ordering costs:
Seeds: 12 × $4.25 = $ 51.00
Fertilizer: 5 × $8.80 = 44.00 95.00
Setup costs:
Onions: 9 × $50.00 = 450.00
Total cost
$1,069.13
f. The growing of onions is very similar in most
respects to a factory production setting. However, the
length of time from the beginning of the process to the
end of the process is likely to be much longer and
therefore require more careful planning. An incorrect
estimate of demand cannot be remedied in any time
shorter than the growing cycle of the onion plant.
Also, weather and local growing conditions may be
additional constraints on the production decision.
Further, the yield is likely to vary much more for
onions than other production processes because some of
the critical inputs are beyond the control of managers
(sunshine and rain, for example).
g. Yes, there are some inconsistencies. Because
the growing of onions is a cyclical event, as opposed to
a continuous event, there should be a very close
relationship between the required quantities of onions,
fertilizer, and seeds. Inventories should be minimal and
be ordered in quantities that match input requirements
for each growing cycle. The EOQ quantities differ from
the cycle quantities.
452 Chapter 16
Cases
55. a. 1. The two costs Stanly of Chemcon

Corporation is attempting to balance in this
situation are:
1. the transaction [or ordering
costs incurred in the buying and selling of
securities ($125 per transaction)]. A larger
average cash balance will result in lower
(less frequent) transaction costs.
2. the return that could have
been earned on securities or other investments
held in lieu of cash. The larger the average
cash balance, the higher the holding costs and
the lower the return because cash provides no
return.
2. Monthly cash outflows $2,650,000
Monthly cash inflows 2,500,000
Monthly cash drain $ 150,000
Months in year × 12
Annual cash drain $1,800,000
EOQ = SQRT(2QO ÷ C)
= SQRT[(2 × 1,800,000 × 125) ÷ 0.08]
= $75,000
b. 1. Ave. balance = (beginning balance + ending balance) ¸ 2
= ($60,000 + $0) ¸ 2
= $30,000
2. Number of times = annual demand ¸ EOQ
= (12 × $150,000) ¸ $60,000
= 30 times
c. Chemcon Corporation can apply the EOQ model in
cash management because its cash inflows, cash outflows,
and net cash flow are evenly distributed throughout the
period. However, any economic change that would cause
the net cash flows not to be evenly distributed would
render the EOQ model inappropriate for cash management.
Economic circumstances that would disrupt Chemcon's net
cash flows include the following:
* The large proportion of Chemcon's
customers with governmental and notforprofit
institutions which tend to be stable economic
units. The payment patterns of these customers are
regular. If Chemcon's customer base should shift
to more seasonal customers, this would upset the
timing of cash inflows.
* If the expected annual interest rate
(8%) on marketable securities should begin to
fluctuate, the EOQ model may not be as appropriate.
Chapter 16
451
(CMA adapted)
Reality Check
56. a. A key consideration would be to minimize
the probability of having obsolete products and product
components on hand. With the rapid rate of product
obsolescence, the firm would only want to produce to
satisfy immediate demand; no stockpiling would occur.
Also, the firm would want to have a production system
that could be quickly adapted from the production of one
product to another.
b. The firm would want to use a pullbased
inventory control system. Such a system would avoid the
accumulation of materials and components that might be
rendered obsolete or unusable due to technical
innovations within the firm and by competitors.
c. It would have the effect of reducing the EPR. The
EPR would be reduced because of the high carrying cost
of inventory. Inventory carrying costs would be high
because included in the inventory carrying costs would
be a component to account for the cost of product
obsolescence.
(CMA adapted)
57. The president should ask for a formal analysis of the
situation. This analysis should address the costs and
benefits of each alternative. Costs should include purchase
prices, warehousing costs (including insurance), personnel to
operate the warehouse and take any necessary inventories
during the year's period, the cost of capital on the funds
tied up in the parts, and penalties for canceling. The supply
director should comply with the president's request by
preparing and presenting an objective report.
Often, when confronted by situations such as this
one, the only costs that are considered are the direct costs
(purchase price and penalties). Decision making of this
nature should be careful to reflect not only the directly
visible costs but also the "hidden costs" of purchase
arrangements.
58. a. As technology changes the relative costs of
ordering and carrying inventory change. The changes
mentioned in this scenario would appear to lower the
costs of ordering inventory. Consequently, assuming the
costs of carrying inventory remain at their original
level, the reduction in ordering costs would drive the
EOQ quantity down.
b. For the reasons cited in part (a), the EOQ
quantity would be reduced.
452 Chapter 16
Chapter 16
451
59. JIT requires close relations and communications with
suppliers. Preferably, there should be a few, wellcultivated
suppliers who are "trained" to know precisely your inventory
needs and who understand the critical requirement of meeting
your justintime operation schedule. Further, they should be
made aware that they will be dismissed for defective or
inappropriate products or service or for failure to meet
delivery schedules. All of the above requires continual close
communications between the vendor and the JIT producer.
In this case, William Manufacturing needs to consider
whether some or all of the responsibility rests with the
company itself. Have the vendors been properly "trained" and
made precisely aware of product and timing needs? Have the
vendors been chosen with the expertise, facilities and
delivery capability to service Johnson's requirements? Do
William's personnel know exactly what the needs are, and are
those needs fairly stable? If, for example, William has
frequent engineering changes because of inadequate product
development, supplier compliance is hampered.
Finally, JIT systems cannot be fully and effectively
implemented in a few months. It usually takes considerably
longer to make the system work well. Expectations that JIT
can have immediate perfect results are likely to lead to
disappointment.
60. Each student will have a different answer. No
solution provided.
452 Chapter 16
61. JIT management of food in a fastfood restaurant can
generate many benefits. Such management of inventory can
reduce inventory levels, improve the freshness of food
served, and increase customer satisfaction.
The ability to implement JIT depends on the company’s
ability to “forecast” demand for all of its products. Demand
must be forecasted accurately so that the company’s suppliers
deliver the right inputs at the right times and so that the
company will have on hand the right number of employees to
provide conversion operations. With an accurate demand
forecast, the company can coordinate deliveries with
suppliers to meet the forecasted level of sales for each
product. Also, the company can develop a work schedule that
will have the right number of employees working during each
part of the work day. Because demand will fluctuate during
the day with peaks around usual meal times, deliveries of
inputs should occur during the slack times of the day. Other
tasks such as cleaning should also be scheduled to be
performed during the slack periods of the day. By training
employees to both prepare and deliver food as well as to
receive inventory shipments from suppliers, employees can be
kept busy throughout the day. During peak times, all
employees will be busy serving customers; during slack
periods, some of their time can be dedicated to preparing for
the next peak period including restocking inventory items.
62. JIT is not for all businesses. Several factors that
determine the success of JIT implementations are discussed
below.
· Cooperation of suppliers. If suppliers are unable or
unwilling to deliver on a JIT basis, the
implementation of JIT is impossible.
· Reliability of freight and alternative distribution
channels. Only if a reliable means of delivering
inputs exists can JIT work effectively. If no means
exists of continually assuring delivery of required
inputs, then implementation of JIT will result in
stockouts and dissatisfied customers. Factors such
as weather, and geographical location can affect
reliability of deliveries dramatically.
· Organizational philosophy. A company must be focused on
developing the highest quality production systems to
implement JIT. Production of defective units results
in missed delivery dates to customers. A firm must
be devoted to constant improvement of the product and
production process to effectively use JIT.
· Organizational culture. JIT production has a much greater
opportunity to be successfully implemented in
organizations which have a culture that embraces
changes, encourages worker empowerment, and has the
ability to deliver required training to its
employees.
Chapter 16
451
· Factory arrangement. JIT implementation is likely to be
more successful in factories that are arranged so
that workers in sequential production processes can
visually communicate with each other. The more
disjointed the production process, the more difficult
the communication will be between workstations.
Effective communication between workstations is
necessary in JIT production.
· Fast setups. Companies that produce many products on a
given production line must have the ability to switch
between the production of one product and another.
Often, reduced setup times and setup costs require
the implementation of higher technology. Firms must
be willing and able to commit to such investments.
· Communication with customers. An accurate shortterm
forecast of demand is necessary to manage inventories
on a JIT basis. Such a forecast relies on effective
communication with customers. Firms must have in
place reliable communication channels to develop the
required forecasts.
63. The following are some of the benefits expected from
such an investment:
∙23 significantly reduced product development costs,
∙24 greatly enhanced speed in developing new products,
∙25 increased ability to respond quickly and effectively to
swings in customer demand and competitive threats,
∙26 enhanced standardization because the software turns every
aspect of a product into digital and mathematical models,
∙27 fewer engineering changes, and
∙28 faster and less costly ramping up to production.
64. Each student will have a different answer. No solution
provided.
65. Each student will have a different answer. No solution
provided.

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Chapter 16

34. Storage $0.06

39. a. SP × AQ SP × SQ

Time of Afternoon Output

43. EOQ (Wonder Cream) = SQRT (2QO ÷ C)

52. a. (1) Raw and In Process 24,904,000

(2) Conversion costs 3,000,000

(3) Raw and In Process 2,912,000

(5) Conversion costs 14,442,000

(6) Raw and In Process 14,448,000

55. a. 1. The two costs Stanly of Chemcon

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