MOV plc produces custom-built sensors. Each sensor has a standard circuit board (SCB) in it. The current average contribution from a sensor is £400. MOV plc’s business is steadily expanding and in the year just ending (2001/2002), the company will have produced 55,000 sensors. The demand for MOV plc’s sensors is predicted to grow over the next 3 years:Year___________________________________ Units2002/03.................................................. 58,0002003/04.................................................. 62,0002004/05.................................................. 65,000

The production of sensors is limited by the number of SCBs the company can produce. The present production level of 55,000 SCBs is the maximum that can be produced without overtime working. Overtime could increase annual output to 60,500, allowing production of sensors to also increase to 60,500. However, the variable cost of SCBs produced in overtime would increase by £75 per unit. Because of the pressure on capacity, the company is considering having the SCBs manufactured by another company, CIR plc. This company is very reliable and produces products of good quality. CIR plc has quoted a price of £116 per SCB, for orders greater than 50,000 units a year. MOV plc’s own costs per SCB are predicted to be:....................................................................... £Direct material........................................... 28Direct labour.............................................. 40Variable overhead..................................... 20 (based on labour cost)Fixed overhead.......................................... 24 (based on labour cost and output of 55,000 units)Total cost.................................................. 112The fixed overheads directly attributable to SCBs are £250,000 a year; these costs will be avoided if SCBs are not produced. If more than 59,000 units are produced, SCBs’ fixed overheads will increase by £130,000. In addition to the above overheads, MOV plc’s fixed overheads are predicted to be:

MOV plc currently holds a stock of 3,500 SCBs but the production manager feels that a stock of 8,000 should be held if they are bought in; this would increase stockholding costs by £10,000 a year. A purchasing officer, who is paid £20,000 a year, spends 50% of her time on SCB duties. If the SCBs are bought in, a liaison officer will have to be employed at a salary of £30,000 in order to liaise with CIR plc and monitor the quality and supply of SCBs. At present, 88 staff are involved in the production of SCBs at an average salary of £25,000 a year: if the SCBs were purchased, 72 of these staff would be made redundant at an average cost of £4,000 per employee. The SCB department, which occupies an area of 240 × 120 square metres at the far end of the factory, could be rented out, at a rent of £45 per square metre a year. However, if the SCBs were to be bought in, for the first year only MOV plc would need the space to store the increased stock caused by outsourcing, until the main stockroom had been reorganized and refurbished. From 2003/04, the space could be rented out; this would limit the annual production of sensors to 60,500 units. Alternatively the space could be used for the production of sensors, allowing annual output to increase to 70,000 units if required.

Required:a) Critically discuss the validity of the following statement. It was produced by Jim Elliot, the company’s accountant, to show the gain for the coming year (2002/03) if the SCBs were to be bought in.

Saving in:...................................................................................................................... £Manufacturing staff – salaries saved: 72 staff × £25,000........................ 1,800,000Purchasing officer – time saved....................................................................... 10,000Placing orders for SCB materials: 1,000 orders × £20 per order.................. 20,000Transport costs for raw materials for SCBs..................................................... 45,000Cost saved....................................................................................................... 1,875,000Additional cost per SCB: (£116 – £112) × 58,000 units.................................. 232,000Net gain if SCBs purchased............................................................................ 1,643,000.......................................................................................................................... (10 marks)b) i) Produce detailed calculations that show which course of action is the best financial option for the three years under consideration. (Ignore the time value of money.) (12 marks)ii) Advise the company of the long-term advantages and disadvantages of buying in SCBs.