Course Project Objective

The Cost Analysis for Decision Making project is intended to be a comprehensive evaluation of the key objectives covered throughout this course. It will challenge you to apply your knowledge of cost information when evaluating the decision to make or buy a product. Please use this outline and grading rubric as a guide to completing your course project. It provides specific details of the required elements of the project, and it will be used by your instructor as a grading guide.

Read Integrative Case 4-61, "Make versus Buy," on pages 157 and 158 (ATTACHED) of the course text. Assume that you are the general manager (Mr. Walsh) faced with this decision. You have identified the following four alternatives available to Liquid Chemical Co.

• Alternative A: It is the status quo. (i.e., Liquid Chemical Co. will continue making the containers and performing maintenance.)
• Alternative B: Liquid Chemical Co. will continue making the containers, but it will outsource the maintenance to Packages, Inc.
• Alternative C: Liquid Chemical Co. will buy containers from Packages, Inc., but it will perform the maintenance.
• Alternative D: It is completely outsourced. Packages, Inc. will make the containers and provide the necessary maintenance.

Your project should include the following items:

• Part (a): Discuss each of the four alternatives outlined above. Identify the relevant costs (including amounts) for each of the four alternatives, and explain why these costs are relevant to the decision. Identify any costs that are not relevant, and explain why they are not relevant. What are the advantages and disadvantages of each alternative? Who benefits and who loses?
• Part (b): Other than the relevant costs identified in Part (a), what additional information would you use when making your decision? Are there financial factors other than those identified in the case study that you would incorporate into your decision? What nonfinancial information would affect your decision?
• Part (c): As the general manager, which alternative would you choose, and why? Support your conclusion with facts and figures, as necessary.

Guidelines

The following guidelines should be used when completing your project:

• The essaymust be at leastthreetofive pages in length, double spaced, and 10 point Arial or Times New Roman font.
• Even though this is not a necessarily a scientific writing paper since it is creative in nature, references are still important. At least one authoritative, outside reference is required (anonymous authors are not acceptable). These should be listed on the last page titled "Works Cited." The reference page does not count towards the minimum page count.
• Appropriate citations are required.
• Essaysare due during Week 7 of this course.
• Any questions about this paper may be discussed in the weekly Q & A Discussion topic.
• This paper is worth 150 total points and will be graded on quality of content, organization, proper use of citations (as necessary), and grammar and sentence structure.

Grading Rubrics

Content	90	60%	Address all parts of the project in sufficient detail. Demonstrate an understanding of course content through its proper application to the decision in the case study. Provide support for your analysis and decision.
Organization and Cohesiveness	25	17%	Present a clear analysis of the decision in the case study. Arrange your responses to all of the parts of the project in a logical fashion.
Documentation and Formatting	20	13%	Use the project guidelines described above. Essays should be in Arial or Times New Roman, 10 point font, double spaced, and a minimum of 3 to 5 pages, excluding the cover page and the reference page. Effectively use information from the course text and outside resources, properly citing in the body of the report, where appropriate, and in the reference page.
Editing	15	10%	Use proper grammar and English. Avoid typos, spelling errors, slang, and jargon.
150	100%	A quality paper will meet or exceed all of the above requirements.

Required

• Cover Page: On the cover page, include who prepared the paper, who you prepared the paper for, and the date.
• Table of Content: List the main ideas and sections of your paper and the pages in which they are located.

Additional hints on preparing the best possible project:

• Apply a three step process of writing: plan, write, and complete.
• Complete a first draft, and then go back to edit and evaluate.
• Use visual communication to further clarify and support the written part of your report. You could use graphs, diagrams, charts, and tables.

Make versus Buy The Liquid Chemical Company manufactures and sells a range of high-grade products. Many of these products require careful packaging. The company has a special patented lining made that it uses in specially designed packing containers. The lining uses a special material known as GHL. The firm operates a department that maintains and repairs its packing containers to keep them in good condition and that builds new ones to replace units that are damaged beyond repair. Mr. Walsh, the general manager, has for some time suspected that the firm might save money and get equally good service by buying its containers from an outside source. After careful inquiries, he has approached a firm specializing in container production, Packages, Inc., and asked for a quotation. At the same time, he asked Mr. Dyer, his chief accountant, to let him have an up-todate statement of the costs of operating the container department. Within a few days, the quotation from Packages, Inc., arrived. The firm proposed to supply all the new containers requiredat that time, running at the rate of 3,000 per yearfor $1,250,000 a year, the contract to run for a guaranteed term of five years and thereafter renewable from year to year. If the number of containers required increased, the contract price would increase proportionally. Packages, Inc., also proposed to perform all maintenance and repair work on existing packaging containers for a sum of $375,000 a year, on the same contract terms. Mr. Walsh compared these figures with Mr. Dyer's cost figures, which covered a year's operations of the container department of the Liquid Chemical Company and appear in Exhibit 4.13. Walsh concluded that he should immediately close the packing container department and sign the contracts offered by Packages, Inc. He felt an obligation, however, to give the manager of the department, Mr. Duffy, an opportunity to question his decision before acting. Walsh told Duffy that Duffy's own position was not in jeopardy. Even if Walsh closed his department, another managerial position was becoming vacant to which Duffy could move without any loss of pay or prospects. The manager Duffy would replace also earned $80,000 per year. Moreover, Walsh knew that he was paying $85,000 per year in rent for a warehouse a couple of miles away that was used for other corporate purposes. If he closed Duffy's department, he'd have all the warehouse space he needed without renting additional space. Duffy gave Walsh a number of considerations to think about before he closed the department: \"For instance,\" he said, \"what will you do with the machinery? It cost $1,200,000 four years ago, but you'd be lucky if you'd get $200,000 for it now, even though it's good for another five years. And then there's the stock of GHL (a special chemical) we bought a year ago. That cost us $1,000,000, and at the rate we're using it now, it'll last another four years. We used up only about one-fifth of it last year. Dyer's figure of $700,000 for materials includes $200,000 for GHL. But it'll be tricky stuff to handle if we don't use it up. We bought it for $5,000 a ton, and you couldn't buy it today for less than $6,000. But you'd get only $4,000 a ton if you sold it, after you'd covered all the handling expenses.\" Exhibit 4.13 Liquid Chemical Company: Container Department Materials Labor Supervisor Workers Department overheads Manager's salary Rent on Container Department Depreciation on machinery Maintenance of machinery Other expenses $ 700,000 50,000 450,000 $ 80,000 45,000 150,000 36,000 157,500 Proportion of general administrative overheads Total cost of department for the year 468,500 $1,668,500 225,000 $1,893,500 Walsh also worried about the workers if he closed the department. \"I don't think we can find room for any of them elsewhere in the firm. However, I believe Packages would take all but Hines and Walters. Hines and Walters have been with us since they left school 40 years ago. I'd feel bound to give them a supplemental pension$15,000 a year each for five years, say. Also, I'd figure a total severance pay of $20,000 for the other employees, paid in a lump sum at the time we sign the contract with Packages.\" Duffy showed some relief at this. \"But I still don't like Dyer's figures,\" he said. \"What about this $225,000 for general administrative overheads? You surely don't expect to sack anyone in the general office if I'm closed, do you?\" Walsh agreed. \"Well, I think we've thrashed this out pretty well,\" said Walsh, \"but I've been turning over in my mind the possibility of perhaps keeping on the maintenance work ourselves. What are your views on that, Duffy?\" \"I don't know,\" said Duffy, \"but it's worth looking into. We wouldn't need any machinery for that, and I could hand the supervision over to the current supervisor who earns $50,000 per year. You'd need only about one-fifth of the workers, but you could keep on the oldest and save the pension costs. You'd still have the $20,000 severance pay, I suppose. You wouldn't save any space, so I suppose the rent would be the same. I don't think the other expenses would be more than $65,000 a year.\" \"What about materials?\" asked Walsh. \"We use 10 percent of the total on maintenance,\" Duffy replied. \"Well, I've told Packages that I'd give them my decision within a week,\" said Walsh. \"I'll let you know what I decide to do before I write to them.\" Assume the company has a cost of capital of 10 percent per year and uses an income tax rate of 40 percent for decisions such as these. Liquid Chemical would pay taxes on any gain or loss on the sale of machinery or the GHL at 40 percent. (Depreciation for book and tax purposes is straight-line over eight years.) The tax basis of the machinery is $600,000. Also assume the company had a five-year time horizon for this project and that any GHL needed for Year 5 would be purchased during Year 5. Required a. What are the four alternatives available to Liquid Chemical? b. What action should Walsh take? Support your conclusion with a net present value analysis of all the mutually exclusive alternatives. Be sure to consider factors not explicitly discussed in the case that you think should have a bearing on Walsh's decision. c. What, if any, additional information do you think Walsh needs to make a sound decision? Why? Relevant Costs Status Quo Materials Labor: Supervisor Workers Overhead: Manager's salary Rent Depreciation Maintenance Other expenses Other: Pension Severance Contract Costs Gen. Admin. Overhead $ 700,000 $ $ 50,000 450,000 $ $ $ $ $ 80,000 45,000 150,000 36,000 157,500 $ 225,000 Total $ 1,893,500 Alternative A - Alternative B Alternative C - - Alternative D - Relevant Costs Alternative A Materials Labor: Supervisor Workers Overhead: Manager's salary Rent Depreciation Maintenance Other expenses Other: Pension Severance Contract Costs $ Year 1 700,000 $ Year 2 700,000 $ Year 3 700,000 ### $ Year 5 700,000 Total 3,500,000 $ $ 50,000 $ 450,000 $ 50,000 $ 450,000 $ 50,000 450,000 ### $ ### $ 50,000 450,000 250,000 2,250,000 $ $ $ $ $ 80,000 45,000 150,000 36,000 157,500 80,000 45,000 150,000 36,000 157,500 80,000 45,000 150,000 36,000 157,500 ### ### ### ### ### 80,000 45,000 150,000 36,000 157,500 400,000 225,000 750,000 180,000 787,500 Total $ $ $ 1,668,500 $ 667,400 $ 1,001,100 $ 1,668,500 $ 667,400 $ 1,001,100 $ 1,668,500 $ 667,400 $ 1,001,100 $ 1,668,500 $ 667,400 $ 1,001,100 $ 1,668,500 667,400 1,001,100 $ 8,342,500 3,337,000 5,005,500 Materials Labor: Supervisor Workers Overhead: Manager's salary Rent Depreciation Maintenance Other expenses Other: Pension Severance Contract Costs $ Year 1 630,000 $ Year 2 630,000 $ Year 3 630,000 $ Year 4 630,000 $ Year 5 630,000 $ Total 3,150,000 $ $ 50,000 $ 360,000 $ 50,000 $ 360,000 $ 50,000 360,000 $ ### $ 360,000 $ 50,000 $ 360,000 $ 250,000 1,800,000 $ $ $ $ $ 45,000 150,000 36,000 65,000 45,000 150,000 36,000 65,000 $ $ $ $ $ 45,000 150,000 36,000 65,000 ### ### ### ### ### $ $ 20,000 $ 375,000 $ - $ 375,000 $ 375,000 Total costs Tax Savings Net costs $ $ $ 1,731,000 $ 692,400 $ 1,038,600 $ 1,711,000 $ 684,400 $ 1,026,600 $ Tax Savings Net costs $ $ $ - $ $ $ $ $ $ $ $ - $ $ $ $ $ $ $ $ Year 4 - $ $ $ $ $ ### $ ### $ ### $ - - Alternative B $ $ $ $ $ 1,711,000 $ 684,400 $ 1,026,600 $ $ $ $ $ $ 45,000 150,000 36,000 65,000 $ $ $ $ $ 225,000 750,000 180,000 325,000 ### $ ### $ $ - $ 375,000 $ 20,000 1,875,000 1,711,000 $ 684,400 $ 1,026,600 $ 1,711,000 $ 684,400 $ 1,026,600 $ 8,575,000 3,430,000 5,145,000 Alternative C Materials Labor: Supervisor Workers Overhead: Manager's salary Rent Depreciation Maintenance Other expenses Other: Pension Severance Contract Costs Loss on sale of materials Loss on sale of machine $ $ Total costs Tax Savings Net costs Savings in cost of capital On Material sale On machine sale Net costs after cost of capital Year 1 70000 Year 2 70000 Year 3 70000 Year 4 70000 Year 5 70000 Total 350000 50000 90000 50000 90000 50000 90000 50000 90000 50000 90000 250000 450000 0 45000 0 0 65000 0 45000 0 0 65000 0 45000 0 0 65000 0 45000 0 0 65000 0 45000 0 0 65000 0 225000 0 0 325000 15000 20000 1250000 90,000 400,000 15000 20000 1250000 0 0 15000 20000 1250000 0 0 15000 20000 1250000 0 0 15000 20000 1250000 0 0 75000 100000 6250000 90000 400000 2095000 838000 1257000 1605000 642000 963000 1605000 642000 963000 1605000 642000 963000 1605000 642000 963000 8515000 3406000 5109000 36000 20000 1201000 36000 20000 907000 36000 20000 907000 36000 20000 907000 36000 20000 907000 180000 100000 4829000 Alternative D Year 1 Year 2 Year 3 Year 4 Year 5 Total Materials Labor: Supervisor Workers Overhead: Manager's salary Rent Depreciation Maintenance Other expenses Other: Pension Severance Contract Costs Loss on sale of materials Loss on sale of machine $ - $ - $ - ### $ - $ - $ $ - $ $ - $ $ - ### $ ### $ - $ $ - $ $ $ $ $ - $ $ $ $ $ - $ $ $ $ $ - ### ### ### ### ### $ $ $ $ $ - $ $ $ $ $ - $ $ $ $ $ 15,000 20,000 1,625,000 160,000 400,000 $ $ $ $ $ Total costs Tax Savings Net costs Savings in cost of capital On Material sale On machine sale Net costs after cost of capital $ $ $ $ $ $ $ $ $ 15,000 1,625,000 - $ $ $ $ $ 15,000 1,625,000 $ - ### ### 1,625,000 ### ### 2,220,000 $ 888,000 $ 1,332,000 $ 1,640,000 $ 656,000 $ 984,000 $ 1,640,000 $ 656,000 $ 984,000 $ 64000 20000 1,248,000 $ 64000 20000 900,000 $ 64000 20000 900,000 $ 15,000 1,625,000 - $ $ $ $ $ 75,000 20,000 8,125,000 160,000 400,000 1,640,000 $ 656,000 $ 984,000 $ 1,640,000 $ 656,000 $ 984,000 $ 8,780,000 3,512,000 5,268,000 64000 20000 900,000 $ 64000 $ 20000 $ 900,000 $ 320,000 100,000 4,848,000 - Name of Student Class Attended Name of Professor Date Submitted This paper deals with make or buys decision of containers and with maintenance of containers by Liquid Chemical Company or to outsource it. Presently company is manufacturing and maintaining containers by itself and annual cost as mentioned by company is $1,893,500 per year of which $225,000 is allocated cost of proportion of general administrative overheads which is irrelevant cost for the purpose of decision making. The company is approached by Packages Inc., which has given offer to manufacture containers for company at annual cost of $1,250,000. Packages Inc. has also given offer for maintenance of containers at annual cost of $375,000. Liquid Chemical Company now has four alternatives as mentioned below; Alternative A: The Company continues status quo and manufacture and maintains containers itself by continuing department: If company continues manufacturing and maintenance of containers, total cost after tax savings for coming 5 years comes $5,005,500. Alternative B: The Company continues manufacturing of containers but outsource maintenance: If company continues manufacturing and maintenance of containers, total cost after tax savings for coming 5 years comes $5,145,000. Alternative C: The Company will buy containers and perform maintenance by itself: If company continues manufacturing and maintenance of containers, total cost after tax savings for coming 5 years comes $4,829,000. Alternative D: The Company discontinue department and outsource both manufacturing and maintenance of containers. If company continues manufacturing and maintenance of containers, total cost after tax savings for coming 5 years comes $4,848,000. Computation for all four alternatives: Relevant Costs Alternative A Year 1 Materials Labor : Supervisor Workers Overhead: Manager's salary Rent Depreciation Maintenance Other expenses Year 2 Year 3 Year 4 Year 5 Total $ 700,000 $ 700,000 $ 700,000 $ 700,000 $ 700,000 $ 50,000 $ 450,000 $ 50,000 $ 450,000 $ 50,000 $ 450,000 $ 50,000 $ 450,000 $ 50,000 $ 450,000 $ 80,000 $ 45,000 $ 150,000 $ 36,000 $ 157,500 $ 80,000 $ 45,000 $ 150,000 $ 36,000 $ 157,500 $ 80,000 $ 45,000 $ 150,000 $ 36,000 $ 157,500 $ 80,000 $ 45,000 $ 150,000 $ 36,000 $ 157,500 $ 80,000 $ 45,000 $ 150,000 $ 36,000 $ 157,500 $ $ $ $ 1,668,500 $ 667,400 $ 1,001,100 $ $ $ $ 1,668,500 $ 667,400 $ 1,001,100 $ $ $ $ 1,668,500 $ 667,400 $ 1,001,100 $ $ $ $ 1,668,500 $ 667,400 $ 1,001,100 $ $ $ $ 1,668,500 $ 667,400 $ 1,001,100 Year 1 $ 630,000 Year 2 $ 630,000 Year 3 $ 630,000 Year 4 $ 630,000 Year 5 $ 630,000 Total $ 3,150,000 $ 50,000 $ 360,000 $ 50,000 $ 360,000 $ 50,000 $ 360,000 $ 50,000 $ 360,000 $ 50,000 $ 360,000 $ 250,000 $ 1,800,000 $ - $ - $ - $ - $ - $ - 3,500,000 250,000 2,250,000 400,000 225,000 750,000 180,000 787,500 Other: Pension Severance Contract Costs Total Tax Savings Net costs 8,342,500 3,337,000 $ 5,005,500 Alternative B Materials Labor : Supervisor Workers Overhead: Manager's salary Rent Depreciation Maintenance Other expenses $ 45,000 $ 150,000 $ 36,000 $ 65,000 $ 45,000 $ 150,000 $ 36,000 $ 65,000 $ 45,000 $ 150,000 $ 36,000 $ 65,000 $ 45,000 $ 150,000 $ 36,000 $ 65,000 $ 45,000 $ 150,000 $ 36,000 $ 65,000 $ 225,000 $ 750,000 $ 180,000 $ 325,000 $ $ 375,000 $ 1,711,000 $ 684,400 $ 1,026,600 $ $ 20,000 $ 1,875,000 $ 8,575,000 $ 3,430,000 $ 5,145,000 Other: Pension Severance Contract Costs Total costs Tax Savings Net costs $ 20,000 $ 375,000 $ 1,731,000 $ 692,400 $ 1,038,600 $ $ 375,000 $ 1,711,000 $ 684,400 $ 1,026,600 $ $ 375,000 $ 1,711,000 $ 684,400 $ 1,026,600 $ $ 375,000 $ 1,711,000 $ 684,400 $ 1,026,600 Alternative C Materials Labor : Supervisor Workers Overhead: Manager's salary Rent Depreciation Maintenance Other expenses Other: Pension Severance Contract Costs Loss on sale of materials Loss on sale of machine Total costs Tax Savings Net costs Savings in cost of capital On Material sale On machine sale Year 1 70000 Year 2 70000 Year 3 70000 Year 4 70000 Year 5 70000 Total 350000 50000 90000 50000 90000 50000 90000 50000 90000 50000 90000 250000 450000 0 45000 0 0 65000 0 45000 0 0 65000 0 45000 0 0 65000 0 45000 0 0 65000 0 45000 0 0 65000 0 225000 0 0 325000 15000 20000 1250000 15000 20000 1250000 15000 20000 1250000 15000 20000 1250000 15000 20000 1250000 75000 100000 6250000 0 0 0 0 90000 0 0 0 0 400000 2095000 838000 1257000 1605000 642000 963000 1605000 642000 963000 1605000 642000 963000 1605000 642000 963000 8515000 3406000 5109000 36000 20000 36000 20000 36000 20000 36000 20000 36000 20000 180000 100000 $ 90,000 $ 400,000 Net costs after cost of capital 1201000 907000 907000 907000 907000 4829000 Alternative D Year 1 Materials Labor : Supervisor Workers Overhead: Manager's salary Rent Depreciation Maintenance Other expenses Year 2 Year 3 Year 4 Year 5 Total $ - $ - $ - $ - $ - $ - $ $ - $ $ - $ $ - $ $ - $ $ - $ $ - $ $ $ $ $ - $ $ $ $ $ - $ $ $ $ $ - $ $ $ $ $ - $ $ $ $ $ - $ $ $ $ $ - $ 15,000 $ 20,000 $ 1,625,000 $ 160,000 $ 400,000 $ 2,220,000 $ 888,000 $ 1,332,000 $ 15,000 $ $ 1,625,000 $ $ $ 1,640,000 $ 656,000 $ 984,000 $ 15,000 $ $ 1,625,000 $ $ $ 1,640,000 $ 656,000 $ 984,000 $ 15,000 $ $ 1,625,000 $ $ $ 1,640,000 $ 656,000 $ 984,000 $ 15,000 $ $ 1,625,000 $ $ $ 1,640,000 $ 656,000 $ 984,000 $ 75,000 $ 20,000 $ 8,125,000 $ 160,000 $ 400,000 $ 8,780,000 $ 3,512,000 $ 5,268,000 Other: Pension Severance Contract Costs Loss on sale of materials Loss on sale of machine Total costs Tax Savings Net costs Savings in cost of capital On Material sale 64000 64000 64000 64000 64000 On machine sale 20000 $ 1,248,000 20000 $ 900,000 20000 $ 900,000 20000 $ 900,000 20000 $ 900,000 Net costs after cost of capital Recommendation: $ 320,000 $ 100,000 $ 4,848,000 Company should go for alternative C which is to buy containers from Packages Inc., and perform maintenance by itself as it will have lowest cost for coming five years