John Lane is the new appointed financial controller of SonicManufacturing Ltd (Sonic). The company specializes in themanufacture of audio and video devices. John met with Tony Chan,Sonic’s plant manager, on the first day of work at his new job.Tony expressed his big concern to John about the current huge cashflow tied up in the inventory stored in the warehouse. He has beenconsidering the implementation of a JIT production project in theplant. However, he is unsure about the benefits, given the risksinvolved for not keeping adequate inventory for production. Johnwas asked to evaluate the proposal and give him the recommendation.The following information are obtained from Tony:
1. Annual cost for JIT production implementation would be$1,000,000.
2. Average inventory would decline by 80% from the current level of$6,000,000
3. The expected savings from insurance, space, warehousing costswould be 80% of the current level of $800,000.
4. Rework costs would be reduced by 50% due to quality improvementachieved from the JIT production system. The company currentlyincurs $200,000 in annual rework costs.
5. The existing annual sales of Sonic’s products are 100,000 unitsat selling price $500 each in average. Improved product qualityunder JIT production would enable the company to have higher valueadded to products and therefore can charge a higher price of $502per unit. However, the company also expects an incremental cost of$200,000 in overtime premiums each year to avoid any loss of salesdue to stockouts. Sonic’s required rate of return on inventoryinvestment is 15% per year.
Required:
a) From a financial perspective, should Tony implement the JITproduction project? Explain.
b) Identify five nonfinancial and qualitative factors Tony shouldconsider when making the decision to adopt JIT production.
c) Assume that Tony has implemented JIT production. Give sixexamples of the performance measures (financial and non-financial)that Tony could use to evaluate and control JIT production.
