The KateSteel Corporation is an automotive supplier that uses automatic turning machines to manufacture precision parts from steel bars. KateSteel’s inventory of raw steel averages $400,000. Keith Abbott, president of KateSteel, and Shaun Silvio, KateSteel’s controller, are concerned about the costs of carrying inventory. The steel supplier is willing to supply steel in smaller lots at no additional charge. Silvio identifies the following effects of adopting a JIT inventory program to virtually eliminate steel inventory:
■ Without scheduling any overtime, lost sales due to stockouts would increase by 25,000 units per year. However, by incurring overtime premiums of $30,000 per year, the increase in lost sales could be reduced to 15,000 units per year. This would be the maximum amount of overtime that would be feasible for KateSteel.
■ Two warehouses currently used for steel bar storage would no longer be needed. KateSteel rents one warehouse from another company under a cancelable leasing arrangement at an annual cost of $60,000. The other warehouse is owned by KateSteel and contains 16,000 square feet. Three-fourths of the space in the owned warehouse could be rented for $3.00 per square foot per year. Insurance and property tax costs totaling $10,000 per year would be eliminated.

KateSteel’s required rate of return on investment is 15% per year. KateSteel’s budgeted income statement for the year ending December 31, 2020, (in thousands) is:

Required

1. Calculate the estimated dollar savings (loss) for the KateSteel Corporation that would result in 2020 from the adoption of JIT purchasing.
2. Identify and explain other factors that KateSteel should consider before deciding whether to adopt JIT purchasing.

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Revenues (1,000,000 units) Cost of goods sold Variable costs Fixed costs Total costs of goods sold Gross margin Marketing and distribution costs Variable costs Fixed costs Total marketing and distribution costs Operating income $6,380 2,820 $2,010 750 $15,000 9,200 5,800 2,760 $ 3,040