Using JIT to reduce inventory holding costs
Burt Manufacturing Company obtains its raw materials from a variety of suppliers. Burt’s strategy is to obtain the best price by letting the suppliers know that it buys from the lowest bidder. Approximately four years ago, unexpected increase in demand resulted in materials shortages. Burt was unable to find the materials it needed even though it was willing to pay premium prices. Because of the lack of raw materials, Burt was forced to close its manufacturing facility for two weeks. Its president vowed that her company would never again be at the mercy of its suppliers. She immediately ordered her purchasing agent to perpetually maintain a one-month supply of raw materials. Compliance with the president’s orders resulted in a raw materials inventory amounting to approximately $1,600,000. Warehouse rental and personnel costs to maintain the inventory amounted to $8,000 per month. Burt has a line of credit with a local bank that calls for a 12 percent annual rate of interest. Assume that Burt finances the raw materials inventory with the line of credit.
Required
a.Based on the information provided, determine the annual holding cost of the raw materials inventory.
b.Explain how a JIT system could reduce Burt’s inventory holding cost.
c.Explain how most-favored customer status could enable Burt to establish a JIT inventory system without risking the raw materials shortages experienced in the past.
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