Arva Furniture: Business Opportunity Evaluation

Background

Ron Hill and his wife Debora have are the founders of Arva Furniture, a small-sized company in Arva, north of London  Ontario that produces wooden yard and patio furniture. Since its establishment in 1975, they have had small orders from rural retailers and occasionally from Parks and recreational centers which they have managed with their existing equipment and staff.  A close church friend introduced Ron to Larry May who was visiting his sister in Arva during the Christmas holidays. Larry is a major maintenance contractor for parks and recreation facilities of many municipalities in Southwestern Ontario. The social conversation between Ron and Larry soon led to a business talk in which Larry told Ron and Deborah he would place an order of 500 benches per year for the next six years if they slightly changed the shape and kind of wood for the legs of the benches he orders. While they welcomed this business opportunity, Ron and Debora requested a week to evaluate the offer before signing it. Larry agreed as he was planning to stay in Arva for ten days.

Next morning at breakfast Debora found Ron quiet and worried so she asked him if it was because of this new business offer. “ I don’t know, Deb”, Ron said “it is a heck of deal for us, but I am worried because delivering 500 benches a year with the specs Larry wants could be challenging! We may need to obtain loans for material and even may need to buy new machinery to deliver this order!” Debra suggested they talk to their foreman, Alex to evaluate the financial and operational challenges they may face. They called Alex to inform him of the offer and asked him to meet them the next day so that they could discuss it.

In their next day meeting Alex outlined two concerns with the new order: 1) timely ordering of the new material (treated maple) for the leg to prevent interruption in production and delivery and b)  the new cutting/shaping of the legs that introduces changes in process. “I am sure you will look after the ordering, Debora, but for the new legs we need to revise our equipment a bit. Alex believed the company had three options: a) buy and refurbish an old carving machine at a cost of $8,000, b) add some new heads to their existing machine at a cost of $11,000 or c) buy a new computerized machine at a cost of $18,000. The three options would be associated with $11, $7 and $4 in labour cost respectively.  Examining their suppliers and their ordering practice Debora estimated $2 (per leg set) for carrying the new material as it has to be kept indoor condition (temperature/moisture controlled warehouse) and the best supplier she found would charge $40 admin fee per order.

With the above information Ron and Debora have hired your group as consultants to help them with the following:
1-Which of the three equipment options would you suggest and why?
2-How many leg sets should Arva furniture order to maintain optimal cost?
3-How many orders per year would be optimal for Arva Furniture?
4-To minimize its costs, what should be the average inventory for Arva Furniture?