Question

is processed further? in Problem 17.30 Plant Shutdown or Continue Operations, Qualitative Considerations. Traditional Analysis KarlAuto Corporation manufactures automobiles, vans, and trucks. Among the various Karl Auto plants around the United States is the Bloomington plant, where vinyl covers and uphols- tery fabric are sewn. These are used to cover interior seating and other surfaces of KarlAuto products. Pam Teegin is the plant manager for the Bloomington cover plant-the first KarlAuto plant in the region. As other area plants were opened, Teegin, in recognition of her management abil- ity, was given the responsibility to manage them. Teegin functions as a régional manager, although the budget for her and her staff is charged to the Bloomington plant. Teegin has just received a report indicating that KarlAuto could purchase the entire annual| output of the Bloomington cover plant from outside suppliers for $32 million. Teegin was aston- ished at the low outside price, because the budget for the Bloomington plant's operating costs was set at $56.45 million. Teegin believes that the Bloomington plant will have to close down operations in order to realize the $24.45 million in annual cost savings. The budget (in thousands) for the Bloomington plant's operating costs for the coming year follows: he Materials Labor Direct $12,000 $13,800 Supervision Indirect plant 3,750 4,300 21,850 Overhead: Depreciation-equipment Depreciation-building Pension expense Plant manager and staff Corporate allocation Total budgeted costs $ 5,000 3,000 5,600 3,000 6,000 o le2 22,600 $56,450 Additional facts regarding the plant's operations are as follows: Due to the Bloomington plant's commitment to use high-quality fabrics in all of its products, the Purchasing Department was instructed to place blanket 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 18 percent of the cost of direct materials. Approximately 600 plant employees will lose their jobs if the plant is closed. This includes all 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, but many others would have difficulty. All employees would have difficulty matching the Bloomington plant's base pay of $29.40 per hour, the highest in the area. A clause in the Bloomington plant'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 serv ice would be 61 million for the year. Some employees would probably elect early retirement because the company has an excellent pension plan. In fact, $4.6 million of next year's pension expense would continue whether or not the plant is open.

Answer 1

2. Qualitative factors to be considered
                              
1. KarlAuto Corpotion should consider the quality of output produced by its Bloomington plant vis- a- vis the quality of output that can be procured from outside suppliers.                              
2. The reliability of outside suppliers needs to be considered as to whether they would be able to consistently supply the output as and when required.                              
3. The company must evaluate the impact of closure of the plant on its public image and goodwill.                               
4. Since 600 employees would lose their jobs as a result of shutdown, it is likely to have an adverse impact on the society. It is also likely to hurt company's goodwill.                              
5. The company should consider the possibility of cost reduction to be able to match its cost of operation with outside suppliers.                              
                              
Decision                              
Although there is likely to be annual savings of $7.45 millions, the decision would be to continue the plant and bring down its cost of operation in the long term.                              

1. QUANTITATIVE ANALYSIS FOR PLANT CLOSURE DECISION STATEMANT SHOWING RELEVANT COST OF CONTINUING THE PLANT PARTICUARS REMARKS $'000 Relevant Variable Cost Relevant Variable Cost 12000 21850 MATERIAL Labour Overheads Depreciation It is only an allocation of sunk cost, and hence, irrelevant Pension Expense 5600 Although pension expense of 4600 would contionue for next year, entire expense can be avoided for further years if the plant is closed. Hence it is a relevant cost Plant manager and staff Since they would not be affected by the closure, it is a committed cost and not relevant Corporate Allocation Since they would not be affected by the closure, it is 39450 Hence, an annual relevant cost of $39.45 millions is incurred to run the plant However, the entire output can be procured from outside supplier for $ 32 million Hence, there would be an annual savings of $7.45 millions from closure if the plant Treatment of non recurring relevant costs Following no recurring following costs have been identified related to closure of plant Cancellation charges on material (12000*0.18) Employment assistance for employees Pension for the next year likely to be incurred even after closure $'000 2160 1000 4600 7760 Hence, an expense of $7.76 million is likely to be incuured in the first year after closure if the plant is shut down, which has not been cosindered in calculation of $7.45 millions annual savings.