Question

Jurica Corporation manufactures various trim pieces for vehicle manufacturers. The company has a number of plants, including the Juriquilla Plant, which makes door trim pieces.

Mr. Bates is both the regional manager for the Central America region and the plant manager of the Juriquilla Plant. His budget as the regional manager is charged to the Juriquilla Plant.

Bates has just heard that the company received a bid from an outside vendor to supply the equivalent of the entire annual output of the Juriquilla Plant for $20.5 million. Bates is astonished at the low outside bid because the budget for the Juriquilla Plant’s operating costs for the upcoming year is $24.16 million. If this bid is accepted, the Juriquilla Plant will be shut.

The budget for the Juriquilla Plant’s operating costs for the coming year is presented below.

Juriquilla Plant Annual Budget for Operating Costs
Materials				$	8,400,000
Labor:
Direct	$	8,500,000
Supervision		410,000
Indirect plant workers		1,500,000			9,310,000
Overhead:
Depreciation—equipment		1,300,000
Depreciation—building		1,700,000
Pension expense		1,400,000
Plant manager and staff		550,000
Corporate expenses*		1,500,000			6,450,000
Total budgeted costs				$	24,160,000

*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 Juriquilla’s commitment to use high-quality fabrics in all of its products, the Purchasing Department was instructed to place yearly 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 300 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 Jurquilla’s base pay of $11.50 per hour, which is the highest in the area. A clause in Juriquilla’s current 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 $0.79 million for the year.

3. Some employees would probably choose early retirement because Jurica Corporation has an excellent pension plan. In fact, $0.61 million of the annual pension expense would continue whether the Juriquilla plant is open or not.c

4. Bates and his staff would not be affected by the closing of the Juriquilla Plant. They would still be responsible for administering three other area plants.

5. If the Juriquilla Plant were closed, the company would realize about $3.68 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. Before looking at the numbers, discuss the human factors and other non-numerical factors that are at play when considering a make or buy decision of this magnitude?

2. Jurica Corporation plans to prepare a financial analysis that will be used in deciding whether or not to close the Denver Cover Plant. Management has asked you to identify:

1. The annual budgeted costs that are relevant to the decision regarding closing the plant.
2. The annual budgeted costs that are not relevant to the decision regarding closing the plant.
3. Any nonrecurring costs that would arise due to the closing of the plant.

3. Looking at the data you have prepared in (1) above,

1. Calculate the financial advantage (disadvantage) of closing the plant. You should calculate this for both the first year and the years after the first year.

2. Based on your analysis as a manager should the plant be closed. Discuss your decision.

Answer 1

1. The human and non-numerical factors that are at play:

• Approximately 300 employees would lose their jobs. Their jobs were possibly the major source of livelihood for these workers.
• The employees so laid off might it difficult to get rehabilitated.
• The economy of the locality might take a hit.
• The image of the company would also be adversely impacted once the stakeholders find out about the plans for shutting down the plant.
• The track record of the outside vendor is very relevant. What happens if they fail to deliver on time? Jurica might end up losing its loyal customer base.
• Jurica would lose control on operations, and would be dependent on the outside vendor.
• If Jurica needs its band of laid off employees again in future, they might be reluctant to join back.

2. a. Annual budgeted costs that are relevant to the decision :

Materials	$ 8,400,000
Labor	9,310,000
Pension Expense	790,000
Budgeted costs that are relevant	$ 18,500,000

$ 610,000 of pension expense would continue, and hence is not relevant. Similarly, the costs pertaining to the plant manager and staff, and corporate expenses would continue, and hence are not relevant. Depreciation expense on equipment and building is allocation of sunk costs, and therefore, they do not matter.

b. Annual budgeted costs that are not relevant to the decision :

Total Budgeted Costs	$ 24,160,000
Less: Budgeted costs that are relevant	18,500,000
Budgeted costs that are not relevant	$ 5,660,000

c. Nonrecurring costs that would arise due to the closure of the plant:

Termination charges for vendors of materials ( $ 8,400,000 x 20 % )	$ 1,680,000
Employment assistance cost	790,000
Total nonrecurring costs	$ 2,470,000

3. a. Financial advantage ( disadvantage) of closing the plant:

	Make	Buy	Financial Advantage ( Disadvantage )
Total budgeted costs that are relevant to the decision	$18,500,000		$ 18,500,000
Nonrecurring costs		$2,470,000	(2,470,000)
Purchase Cost		20,500,000	(20,500,000)
Opprtunity Cost ( Salvage Value)	3,680,000		3,680,000
Totals	$22,180,000	$22,970,000	(790,0000)

b. No. Apart from the qualitative factors discussed above, the total relevant costs to make are lower than the cost of outsourcing.