Floor Cost Cost of Factory Space Carrying Cost of Inventory

The theory here is that there is a certain cost associated with the space occupied by a production center. To the processing cost we should also add the cost of the space and the carrying cost associated with any material inventory required to support the production center.

The same arguments used for determining the capital cost of the machine can be used to determine the capital cost of the space occupied by the machine and it's supporting inventory. In addition, we must add interest costs of the inventory. Obviously, if the inventory wasn't required by the production center, we wouldn't have to pay to keep it in place and costs would be lower.

As you can see, this is getting quite complex and we aren't even finished with the first factor in the Processing Cost. It is important that all of this be considered. Most of these factors have very little effect when production runs are very long and they have generally been discarded as immaterial. When production lots become smaller as they have done in the woodworking industry, these factors actually become dominant. If you ignore them, you will be totally unable to see major potential for improvement.

At this point, we have examined each of the factors needed to determine Machine Cost. As an example, let's calculate the annual Machine Cost for a sample machine. Although these numbers may vary quite a bit, for our purposes let us use a machine and installation cost of $100,000 and an annual interest rate of 10%.

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