Kitchen Rite is considering outsourcing the production of a steel chassis that is used in a kitchen appliance. Two thousand chassis are produced per month. An outside vendor will supply an identical chassis for $ 9.90. The chassis is manufactured in two steps. A stamping press punches out the part from sheet metal, bends the sides, and cuts holes in it, all in one operation. Then a welding machine welds the corners. Both the welding and stamping machines are used to produce only this one chassis model. The following job order cost sheet summarizes the costs of producing a single chassis.
Cost per Unit
Steel plate................ $ 4.75
Direct labor: Stamping ($ 20/ hour) .... 1.60
Welding ($ 30/ hour) ........... 2.50
Overhead: Stamping (depreciation)....... 3.60
Welding (lease payment) ......... 2.15
General plant ................ 5.90
................... $ 20.50
The stamping machine is old and has little economic value. A used equipment dealer is willing to remove the machine and haul it away at no cost. The stamping machine was purchased 13 years ago for $ 1,728,000. For both tax and reporting purposes, it is being depreciated using a 20- year life, straight- line method, and it has zero salvage value. The welding machine is leased for $ 4,300 per month, and the lease can be canceled at any time and the machine returned. However, an early termination penalty of $ 1,800 per month for the next 42 months must be paid.
General plant overhead consists primarily of the allocated cost of depreciation on the plant, property taxes, and fire insurance on the plant. Kitchen Rite currently has excess plant space. The manufacturing space freed up if the chassis is outsourced has no other use.
Employees are unionized and have a clause in their contract that prevents the firm from firing them if their jobs are eliminated due to outsourcing. The employees working on the stamping machine will be placed on indefinite furlough at 75 percent of their current pay. The employees operating the welding machine can be reassigned to other positions in the firm as job openings occur. Given the high demand for welders, these reassignments will occur within a few weeks of outsourcing the chassis.
Kitchen Rite has a tax loss for the current and the previous two years.
Required:
Should Kitchen Rite outsource the chassis? Support your recommendation with a clear financial analysis of the facts.