[stranger_uk123]

SBL produces special containers. They believe that if they outsource them it would be much cheaper.

An outsourcing company EPC is prepared to supply new containers (30,000) per annum for £1,150,000 per year. The contract will cover a term of 5 years.

Irrespective of whether SBL outsource the containers or not, EPC will undertake to carry out purely maintenance work on containers for a sum of £580,000 per annum on the same contarct term.

SBL calculated the following figures which covered a years operation producing containers.

Material £612,500
Labour (Cost expected to increase by 5% each yr) £250,000
Manager's Salary (expected to increase by 10% each yr) £ 50,750
Rent £ 37,700
Depreciation of Machinery £125,625
Maintenance of Machinery £ 25,650
Other departmental exp £137,550
Proportion of SBL general exp £188,450

* Please note that the manager's position is not in jeopardy

SBL put the proposal to the manager to which he replied;

"What will happen with the machinery? It cost £1,050,000 four yrs ago and we would be lucky to get £175,000 for it now even though it should last for at least another 5 yrs.

He further said "What about the lining material for containers? That cost us £875,000 and, at the rate that we are using it now, it will be sufficient for at least 4 more years - we used about one fifth of it last year.

The figures of £612,500 for materials probably includes about £180,000 in respect of lining material.

We bought this lining material for £440 per ton and it cost no less than £525 per ton today. If we were to sell it off, we would not get any more than £350 per ton, net of disposal cost.

During this manufacturing a total of £74,375 a year in rent is being paid towards a small warehouse few miles away from the company to store the material. If we take on the contract we would not need that space.

That is a good point”, said GM, “but I am a little concerned about the workers if we close the department. I don’t think that we would find room for anyone of them elsewhere in the firm. I could see whether EPC could employ them but some of them are nearing retirement age.

For example: Lanchburg and Masters have been with us since they finished school 40 years ago – I would feel bound to give them a small pension of, say, £13,500 a year each.

Department Manager showed some relief at these comments but indicated that he was still not happy with SBL figures. “What about this £188,450 for general administrative overhead,” he said “you surely don’t expect to sack anyone in the general office if my department closed do you?” "NO" said accountant.

The company's general manager suggested that if we outsource the production of containers and keep the maintenance to ourselves it may be worth considering. We will not need any machinery and he would hand over the supervisor to a foreman hence saving half the salary cost in that case.

We will need only one fifth of the workers but we can keep the oldest. We wouldn't save any space here or at the rented warehouse so the rent would be the same. Other expenses would not be more than £56,900 per annum and we use about 10% of the total material on maintenance.

What I require is;

a) What are the concepts of relavant costing and how it might apply to manufacturing company. Illustrate with examples.

b) Without any calculations, identify the business options implicit in the SBL case and comment on the possible costs and benefits of each option.

c) With the assistance of relevant calculations, determine and explain which of that alternative identified in (b) above is most attractive. Justify the approach that you adopt.

(d) Discuss other factors with GM should consider before finalising his decision and indicate how could he obtain the necessary information.

[Curlyben]

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