S0C 200: Case Study Report 1: THREE JAYS CORPORATION; Complete Solution.

S0C 200: Case Study Report 1: THREE JAYS CORPORATION; Complete Solution.1. Using the data in case Exhibit 4 and the 2012 annual demand, calculate the EOQ and ROP quantities for the five SKUs scheduled to be produced in the last week of June. How do these amounts compare with those calculated in 2011? Compare the increases in EOQs with the increases in annual demand. (2.5 points) The 2012 Annual Demand is given as Exhibit 5: Monthly Sales Data Label Type Ja n Fe b Mar Apr Ma y June July Aug Sept Oc t Nov Dec Year Total 3Js Strawberry Jam ,869 2013 566 671 384 631 616 2,868 Marran Markets Raspberry Jelly ,006 379 571 2,856 Kerry's Marts Peach Jam ,970 Dom's Food Stores Blueberry Jam ,211 AAA Grocers Apple/Mint Jelly The EOQ and ROP quantities for the five SKU’s based on 2012 annual demand is given as Total Set up cost (S) Annual Deman d (D) Carryin g Cost (i) % Unit Cost (C) EOQ (cases) ROP (cases) Strawberry Jam 63.7 3869 9% 28. Raspberry Jam 63.7 3006 9% 30. Peach Jam 63.7 1970 9% 26. Page 1 of 12 Case Study 1 – Three Jays Corporation Blueberry Jam 63.7 1211 9% 29.01 243 70 Apple/Mint Jelly 63.7 832 9% 26.32 212 48 As Demand increased from 2011 to 2012, the EOQ’s also increased Deman d (2010) Deman d (2012) Increase in Demand EOQ (2010) EOQ (2012) Increase in EOQ .27% .70% 2335 3006 28.74% .37% .04% .00% .68% .83% .12% .85% So, if Annual Demand doubles, the EOQ will increase by sqrt(2) 2. Brodie is uncertain if the costs presented in case Exhibit 2 are appropriate for determining the EOQs. What changes would you recommend, and why? Should the cost of the three idle part-time workers be included when the production line is down? Using the 2012 annual demand, and your recommendations, recalculate the EOQs for the five SKUs. (2.5 points) In set up costs, the cost of part time workers should also be included, as they are idle at that time. Assuming the salary of each part time worker to be half that of full time worker So, Total salary of 3 part time workers, during idle time of 1 hour = 3*0.5*23.5 = $35.25 So, new set up cost = $63.7 + $35.25 = $98.95 In carrying cost, storage cost was considered as 0%, which should be more because, there is always an opportunity cost of storing one inventory over another. So, considering storage cost as 2%, new carrying cost = 6% + 2% + 3% = 11% Some of the basic assumptions of EOQ are debated • The demand is not uniform throughout the year, which may lead to stock outs • The order of new batch takes time and is not done instantly. For this case, the ROP should be adjusted to include the lead time to place order Page 2 of 12 Case Study 1 – Three Jays Corporation Total Set up cost (S) Annual Demand (D) Carrying Cost (i) % Unit Cost (C) EOQ (cases) ROP (cases) Strawberry Jam 98.% 28. Raspberry Jam 98.% 30. Peach Jam 98.% 26. Blueberry Jam 98.% 29.01 274 70 Apple/Mint Jelly 98.95 832 11% 26.32 238 48 Brodie’s first assignment in his internship is to update the EOQ and ROP quantities for all 141 SKUs, to reflect the current levels of demand (D), because the original calculations were done in 2011 with sales figures from 2010. This task is simple for the ROP, where: 3wks (leadtime) (annual demand) 52(wks/year) ROP  D Making changes to the EOQ amounts is more complicated, as several logical errors exist in the data that are used as inputs for the EOQ formula. Specifically, these are the setup cost (S), the unit cost (C), and the inventory carrying cost, which is expressed here as a percentage (i). (Note: Sometimes the variables i and C are combined in the EOQ formula. When this occurs, the product of i * C is represented by the symbol H, which is the inventory holding cost in dollars per unit, per year.) Errors in Calculating EOQs Setup cost (S) errors These errors result from incorrectly including an allocation of fixed annual expenses as components of the total setup cost. Setup costs should include only actual, out-of-pocket costs (as should all the costs used in the calculation of the EOQ) that are directly related to setting up the production line to make a specific item (SKU). Jake Evans and Josh Francis — as well as the buyers who purchase the raw ingredients and packaging material for 3Js — are full-time workers who earn a predetermined yearly salary. Consequently, reasonable changes in the number of setups per year will not change the total cost of these individuals. Thus, regardless of whether Page 3 of 12 Case Study 1 – Three Jays Corporation they are employed by Fremont Jams and Jellies, or 3Js, there are no incremental costs that are incurred with respect to setups. Therefore, the costs of changing the rails on the assembly line to accommodate different jar sizes — as well as the costs of cleaning the equipment and switching out the jar labels between batch sizes — should not be included in the setup cost (S). Similarly, the costs of the two individuals employed in the kitchen should not be included in the setup costs. These costs should be considered only as the maximum capacity f these individuals is approached and additional people and/or equipment are required. At that point, changes could be considered that would postpone the need for expansion, which would suggest that an appropriate tradeoff analysis should be conducted. Thus, with the current production system, the only relevant setup costs are the part-time wages paid to the three temporary workers, who are idle while the line is shut down for cleaning and label changes. The setup costs are therefore equal to: S = 3 workers * $12.50 per hour * 1 hour = $37.50 Notably, the cost of these temporary workers is not included in the original cost calculations, most likely because they were not working and hence were not considered as part of the setup costs. Nevertheless, their cost is an out-of-pocket expense that must be included. Carrying cost (i) errors The cost of carrying inventory typically consists of three components: (a) the cost of storing the inventory, which can include storage costs (building costs, etc.) and labor and equipment costs associated with storage, insurance, and taxes; (b) the cost of obsolescence, spoilage, and shrinkage; and (c) the cost of capital, which is the cost of the money that is tied up in inventory. Because FJ&J is not charging 3Js for storing its finished goods, the primary component of this parameter is the cost of capital, which can vary. There are three scenarios: 1) If a firm has an excess of cash, then the cost of the capital tied up in inventory is the interest lost that could have been earned by investing the money. 2) If the funds could be better used — other than in inventories — by investing in a project that would generate additional revenues and profits, or significantly reduce costs, then the cost of capital is the opportunity cost associated with not having the funds available for that specific project. Page 4 of 12 Case Study 1 – Three Jays Corporation 3) If the firm needs to borrow money to establish these inventories, then the cost of capital is equal to the interest rate on the borrowed funds. Here, although the cost of borrowing capital is 6%, the actual cost of capital is the opportunity cost associated with the inability of the firm to launch a new marketing campaign due to its lack of funds, which is estimated to be 20%. This is the projected contribution to overhead and profit that the additional revenues would generate. The 3% that is used for storage recognizes that FJ&J is not charging for the actual storage of finished goods, but it does include the cost of obsolescence, insurance, and taxes. Thus, the cost of carrying inventory is: i = 20% + 3% = 23% Unit cost errors (C) Again, we should include only costs that represent out-of-pocket costs associated with the jams and jellies that are being produced. The components of the unit cost (C) should therefore include only those costs that are directly incurred each time a run is made. This is represented in case Exhibit 3 as the “Total Variable Cost,” which does not include the fixed overhead cost allocation; that allocation is currently included in the calculations. Assumptions in the EOQ Calculations There are several assumptions inherent in the EOQ formula, many of which are not applicable to the 3Js situation. These include: 1) Unit cost remains constant and does not vary (as would be the case with quantity disc unts). This is valid, given the information in the case. 2) There are no stock-out costs. While these costs are not mentioned in the case, they need to be considered in determining how much inventory in the form of safety stock to have on hand. 3) Demand is constant and known. At 3Js, however, the firm is g owing; the actual demand is not known, but estimated based on some type of forecasting method. 4) Production capacity is always available when it is needed. In other words, there is no lag time between when product is required and when it is produced. At 3Js, however, the production of a specific size jar is scheduled for a given week, and any requirements Page 5 of 12 Case Study 1 – Three Jays Corporation prior to that week will be delayed until that time. (Note: When Assumptions 3 and 4 are valid, stock-outs most likely will not occur, which is why there is no need to consider them in the EOQ formula.)