Week 7_ Agbato Oluwabusayo__Determining the right deal in material purchase_Week 18 _SeeGod Meregini

Week 7_ Agbato Oluwabusayo__Determining the right deal in material purchase_Week 18 _SeeGod Meregini

Problem Recognition/Evaluation

A new material was to be bought by my purchasing company and I was told to work with the team in evaluating a good deal from a list of alternatives.

The root cause needed for this extra support was because of the following reasons:

· Previous purchases had been made based on incorrect analysis of cost cut deals in the offers.

· Previous purchases had higher prices gotten from hidden charges in the proposed offers

· Improper evaluation of previous vendor deals associated with the purchases materials resulted in more costly investments.

I needed to correctly evaluate the best economic alternative.

In this analysis the life of the materials would exceed one year hence the time value of money is a consideration.

Development of Feasible Alternatives/Solutions

After evaluations of different vendors and cut deals on their materials, three feasible alternatives is used based on cost that would be saved due to cut deals in the offers. The life of each of these materials was 7 years.

In carrying out this analysis, an assumption is that depreciation would not be calculated for each alternative.

Alternative 1-

Material 1

Alternative 2 –

Material 2

Alternative 3-

Material 3

Probable Outcomes of Alternatives / Solutions.

Stakeholders meetings within and between various departments including the vendors were held to determine the various savings included in the offers.

In this analysis evaluation is made on the potential cost savings in each bid offers.

Costs used are factored but have same equivalence with original for the purpose of showing the final result.

A breakdown is given below

Attributes	Material 1	Material 2	Material 3
Saved cost due to free services	$50	$70	$30
Free services	2/year	1/year	3/year
Interest on savings	5%	3%	2%

Selection Criteria in determining the solution

1. The highest cost deal would be selected

2. The most economical material based on cost savings from the deals offered would be selected.

Analysis and Comparison of the alternatives

In finding the present equivalent of the cost of future savings, a cash flow diagram would be used.

The formula below is used in determining the Present Equivalent of this future costs assuming the company is saving these costs (A) annually in a bank at different interest rates based on the provision of the banks.

P = A (P/A, i%, N) ......................................................................................Equation 1

Where:

P = Present Equivalent value

N = Number of compounding (interest) periods

A = Annual Equivalent value (occurs at end of periods 1 through N, inclusive.

Using N = 7 years for all alternatives

Quantitative analysis of the alternatives

A = $50

Alternative 1- Material 1

Time of purchase

14

133

3

2

1

	End of Quarter

P = ?

I = 5%

A = $50

N (Cash flows periods) = 14 free services (2 free services /year * 7 years)

Using equation 1 and Discrete Compounding Tables,

P = $50(P/A, 5%, 14)

= $50 *9.8986

= $494.93

Alternative 2 – Material 2

Using similar cash flow diagram,

I = 3%

A = $70

N (Cash flows periods) = 7 free services (1 free service /year * 7 years)

Using equation 1 and Discrete Compounding Tables,

P = $70(P/A, 3%, 7)

= $70 *6.2303

= $436.1

Alternative 3- Material 3

Using similar cash flow diagram,

I = 2%

A = $30

N (Cash flows periods) = 21 free services (3 free services /year * 7 years)

Using equation 1 and Discrete Compounding Tables,

P = $30(P/A, 2%, 21)

= $30 *17.0112

= $510.336

Selection of Preferred Alternative

Based on the above quantitative analysis and criteria, I recommend ALTERNATIVE 3.

In addition, the fact that material 1 seems to have more cost savings that material 3, this does not mean it is a better deal.

The time value of money effect has resulted in Alternative 3 being chosen.

Performance Monitoring/Post Evaluation

This would be monitored by constantly evaluating

· The other risk factors not being analysed in the calculations like increased cost of maintenance to mention a few.

· The effect of depreciation on the market value of these materials after 7 years.

References

Sullivan, W. G., Wicks, E.M., & Koelling, C.P. (2009). Cost Concepts and Design Economics. In M.J. Horton (Ed.), Engineering economy (15^th ed.) (chapter 4) New Jersey, NJ: Pearson Education, Inc.

United States Government Accountability Office (2009, March). Cost Risk and Uncertainty. GAO Cost Estimating and Assessment Guide. Best Practices for Developing and Managing Capital Program Costs. (chapter 14) (pp.160).Washington, DC: GAO.

AACE International Education Board. (2006). Risk Management. In J.K.Hollmann (Ed), Total cost management framework – A process for applying the Skills & knowledge of cost engineering (1st ed) (chapter 7.6.1) (pp.159-160). Morgantown, West Virginia: AACE International.