Question

Dover Custom Plant—Its Future? Premiere Corporation manufactures seats for automobiles, vans, trucks, and various recreational vehicles. The company has a number of plants around the world, including the Dover Custom Plant, which makes seat covers. Tom Vandiver is the plant manager of the Dover Custom Plant but also serves as the regional production manager for the company. His budget as the regional manager is charged to the Dover Custom Plant. Tom Vandiver has just heard that Premiere Corporation has received a bid from an outside vendor to supply the equivalent of the entire annual output of the Dover Custom Plant for $35 million. Vandiver was astonished at the low outside bid because the budget for the Dover Custom Plant’s operating costs for the upcoming year was set at $52 million. If this bid is accepted, the Dover Custom Plant will be closed down. The budget for Dover Custom’s operating costs for the coming year is presented below.

Dover Custom Plant Annual Budget for Operating Costs

Materials.................................................. $14,000,000

Labor: Direct……………..……………....... $13,100,000

Supervision……………….....……... 900,000

Indirect plant labor…...……….….... 4,000,000 18,000,000

Overhead: Depreciation—equipment.................. 3,200,000

Depreciation—building..................... 7,000,000

Pension expense................................ 5,000,000

Plant manager and staff……..……... 800,000

Corporate expenses*.......................... 4,000,000 20,000,000

Total budgeted costs................................ $52,000,000

*Fixed corporate expenses allocated to plants and other operating units based on total budgeted wage and salary costs.

Additional facts regarding the plant’s operations are as follows:

1. Due to Dover Custom’s commitment to use high-quality fabrics in all of its products, the Purchasing Department was instructed to place blanket purchase orders with major suppliers to ensure the receipt of sufficient materials for the coming year. If these orders are canceled as a consequence of the plant closing, termination charges would amount to 20% of the cost of direct materials.

2. Approximately 400 plant employees will lose their jobs if the plant is closed. This includes all of the direct laborers and supervisors as well as the plumbers, electricians, and other skilled workers classified as indirect plant workers. Some would be able to find new jobs while many others would have difficulty. All employees would have difficulty matching Dover Custom’s base pay of $18.80 per hour, which is the highest in the area. A clause in Dover Custom’s contract with the union may help some employees; the company must provide employment assistance to its former employees for 12 months after a plant closing. The estimated cost to administer this service would be $1.5 million for the year.

3. Some employees would probably choose early retirement because Premiere Corporation has an excellent pension plan. In fact, $3 million of the annual pension expense would continue whether Dover Custom is open or not.

4. Tom Vandiver and his staff would not be affected by the closing of Dover Custom. They would still be responsible for administering three other area plants.

5. If the Dover Custom Plant were closed, the company would realize about $3.2 million salvage value for the equipment and building. If the plant remains open, there are no plans to make any significant investments in new equipment or buildings. The old equipment is adequate and should last indefinitely.

Required:

1. Without regard to costs, identify the advantages to Premiere Corporation of continuing to obtain covers from its own Dover Custom Plant.

2. Premiere Corporation plans to prepare a financial analysis that will be used in deciding whether or not to close the Dover Custom Plant. Management has asked you to identify: a. The annual budgeted costs that are relevant to the decision regarding closing the plant (show the specific dollar amounts in a professional format). b. The annual budgeted costs that are not relevant to the decision regarding closing the plant and explain why they are not relevant (again show the specific dollar amounts in a professional format). c. Any nonrecurring costs that would arise due to the closing of the plant, and explain how they would affect the decision (again show any specific dollar amounts in a professional format).

3. Looking at the data you have prepared in (2) above, should the plant be closed? Show computations in a professional format and fully explain your answer. Be specific.

4. Identify any other factors not specifically mentioned in the problem that Premiere Corporation should consider before making a decision; give thought to factors related to revenues and costs, as well as nonfinancial factors.

Answer 1

1. Advantages to Premiere Corporation of continuing to obtain covers from its own Dover Custom Plant :

• Assurance of QUALITY of material as covers are obtained from own plant. (High quality Fabrics are used)
• No uncertainity of Price Fluctuations which may happen if covers are obtained from outside vendor.
• The 400 Employees will not lose their job.

2. (A) Annual budgeted costs that are relevant to the decision regarding closing the plant :

Relevant Costs	$
Materials	1,40,00,000
Labor: Direct	1,31,00,000
Supervision	900,000
Indirect plant labor	40,00,000
Depreciation—equipment	32,00,000
Depreciation—building	70,00,000
Pension expense	20,00,000	=5000000-3000000
Total Relevant Costs	4,33,00,000

(B) The annual budgeted costs that are not relevant to the decision regarding closing the plant:

Unrelevant Costs	$	Reason
Pension expense	30,00,000	$3 million of the annual pension expense would continue whether Dover Custom is open or not.
Plant manager and staff	8,00,000	Tom Vandiver and his staff would not be affected by the closing of Dover Custom. They would still be responsible for administering three other area plants.
Corporate expenses	40,00,000	It is allocated expense of corporate. It will not be affected by Plant shutting down or not.
Total Unrelevant Costs	78,00,000

(C) Nonrecurring costs that would arise due to the closing of the plant:

Nonrecurring Costs due to shut down	$	Reason
Termination Charges	28,00,000	20% of Direct Material charges are to be paid for cancellation of purchase orders.
Employment Assistance cost	15,00,000	As per contact with union, company must provide employment assistance to it's former employees for 12 months after plant closing.
Salvage value for the equipment and building	-32,00,000	Salvage value will be realized if the plant is closed.
Total Nonrecurring Costs	11,00,000

3. Computation for Decision Making :

Total Relevant cost if plant is closed :
=nonrecurring costs that would arise due to the closing of the plant + Cost of supply from outside vendor
=$1100000 + $35000000
36100000
Total Relevant cost if plant is not closed :
=Total Relevant Cost for decision making
43300000
Net Gain if Plant is Closed :
=43300000-36100000
7200000

Thus, the plant should be closed as there is net gain of $7200000 by closing it.

4. Other factors to be considered :

• The quality of Fabric used by the outside vendor.
• The Longetivity of the contract as per agreed Bid Price.
• The credit period offered by the outside vendor.
• Timely delivery of covers by the outside vendor.

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