Question

Jurica Corporation manufactures various trim pieces for vehicle manufacturers. The company has a number of plants, including the Juriguilla Plant, which makes door trim pieces. Mr. Bates is both the regional manager for the Central America region and the plant manager of the Juriguilla Plant. His budget as the regional manager is charged to the Juriguilla 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 Juriguilla Plant for $20.5 million. Bates is astonished at the low outside bid because the budget for the Juriguilla Plant's operating costs for the upcoming year is $24.16 million. If this bid is accepted, the Juriguilla Plant will be shut. The budget for the Juriguilla Plant's operating costs for the coming year is presented below. $ 8,400,000 9,310,000 Juriguilla Plant Annual Budget for Operating Costs Materials Labor: Direct $8,500,000 Supervision 410,000 Indirect plant workers 1,500,000 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 Total budgeted costs 6,450,000 $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: a. Due to Juriguilla'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. b. 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 Jucauilla's base pay of $11.50 per hour, which is the highest in the area. A clause in Juriguilla'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.

Answer 1

1. The following factors need to be considered while evaluating a make or buy decision of this magnitude:

• The loss of skilled labour force: If the company decides to shut down the plant the company might lose the skilled labour force. If the company decides to restart the plant again after a certain point of time then might become difficult for the company to acquire the skilled labour force.
• Maintaining the quality standards: If the company decides to procure the materials from third party it might have to compromise on the quality which it could have maintained by producing the product in house.
• Additional cost to be incurred to restart the plant: If the company after closing down the plant decides to restart it then it might have to incur additional setup costs to restart the plant.
• Fixed cost: The company might have to incur some of the fixed costs even after closing down the plant. This needs to be considered in a make or buy decision.

2. Relevant costs means those costs which will be incurred only if the plant is operated. Irrelevant costs means those costs which are going to be incurred irrespective of whether the plant is operated or shut down.

Cost	Amount	Relevant / Irrelevant	Reason
Direct materials	8400000	Relevant	This cost will no longer be incurred if the plant is shut down
Termination charges for cancelling the order of direct materials	1680000 [8400000*20%]	Non recurring expenses	Since this cost is to be incurred only once when the plant is shut down
Labour	9310000	Relevant	This cost will no longer be incurred if the plant is shut down
Cost to provide employment assistance to its former employees	790000	Non recurring expenses	This cost is to be incurred only once when the plant is shut down
Depreciation - equipment	1300000	Irrelevant	Since it is a non cash expense, the company does not pay anything whether the plant is operated or shut
Depreciation - building	1700000
Pension	610000	Irrelevant	since this cost will be incurred whether the plant is operated or shut down
	790000 [1400000-610000]	Relevant	This cost will no longer be incurred if the plant is shut down
Plant manager and staff	550000	Irrelevant	since this cost will be incurred whether the plant is operated or shut down
Corporate expenses	1500000	Irrelevant	Since these are mere allocation of expenses, these are irrelevant.

3. (a)

Computation of savings if the plant is shut down:

Description	Amount
Savings in direct material cost	8400000
Termination charges for cancellation of order	(1680000)
Savings in labour cost	931000
Employment assistance cost	(790000)
Savings in pension cost	790000
Salvage value of equipment and building	3680000
Savings if the plant is shut down	11331000

Payment to be done to the outside vendor for the supply of equivalent output = 20500000

Since the payment to be made to the outside vendor is greater than the savings, the company would be at a disadvantage if the plant is shut down.

Amount of disadvantage of closing the plant = 20500000 - 11331000 = 9169000

3.(b) It is clear from the above computation that if the plant is shut down the company will have to incur an additional cost of 9169000. Therefore, as a manager of the plant I would decide to operate the plant and produce the required output rather than procuring it from outside vendor.