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Caustic Soda Solutions (CSS) is looking forward to identify and adapt the most economical option in its business given various cost-benefit scenarios as will be discussed below (Cardy 2008). The following assumptions will hold in the discussion below:
- that CSS wishes to continue operations for a long period of time and at least for five years;
- that the cost of machinery will be the same after four years. That is £240 000;
- that Storm will not alter their terms if the contract were to be taken after four years or any time during the contract;
- tax and inflation will not vary.
From the data given, CSS has the following options:
- contracting Storm company to produce the containers at the annual cost of £ 300 000, including a further £ 87 500 for repair of containers annually;
- retaining the container production operations but contracting the container repair function to Storm at an annual cost of £ 87 500;
- retaining the repair operations but contracting Storm to produce new containers as an annual cost of £ 300 000;
- doing nothing and continuing to spend £ 424 500 for the production and repair of the containers annually;
- an additional option of retaining both functions until either the putron is exhausted in three years or the machinery is due for the replacement in four years, the cost-benefit analysis of which will be computed in the section below (Saunders 2008).
If CSS was to contract both the manufacture and the repair of containers, it would have to sign 5-year contracts of £ 300,000 and £ 87,500 p.a, totaling £ 1,937,500, translating to 387,500 per year. The company would eliminate the following costs: rent contribution £7500, materials £100,000, labour £175,000, machinery maintenance £7500, other expenses £31500, and general administrative overhead £33750. The machinery would have to be sold at 40,000, down from its initial cost of £240,000, a loss of £200,000.
However, if the machinery were to be used for another four years, which is its remaining lifetime, it would still incur expenses in the maintenance and depreciation (£30,000 + £7500) per year, totaling £150,000. This means that a decision to sell the machinery at once would cost the company only £50000 (which is £200000-£150000). The department’s manager’s salary would still be met at £40000 per year, according to Smith’s promise to Dailly. Therefore, a decision to outsource both functions at once would have the company pay £387,500 plus the manager retention sum of 40,000 in the first year, totaling £427,500 (which would be 3000 more than present).
This means that the scenario A would be more costly for CSS the first year .The 5-year contract would therefore cost £427500 X 5, making ££2,137,500 while not contracting would mean spending the present £424,500 with the adjustments for putron stocks still available for the next 3 years, but with the machinery replacement after 4 years at the same assumed cost of 240,000, totaling 2,262,500. Therefore, in the next five years, contracting would save CSS £125,000 (£2262500 -£ 2137500).
This scenario contracts the maintenance function only. This scenario would obviously be unfavorable for the company as it would require paying £87,500 p.a to Storm while still retaining the whole department because the production of new containers would still require all the staff and facilities that are needed at repairs. This would translate to an annual budget of £512,000. This would be the most unfavorable option for CSS.
This has already been suggested by Smith. It could save CSS all expenses, except material about 25 % of materials (assuming putron would not be needed) £25000, labour 30% of £175 000 totaling £52500 (assuming the 20% senior workers retained on Dailly’s recommendation would account for 30% of labor charges), and other overhead at, say, 13,000 p.a. This would total 90,000 p.a. However, on the other side, CSS would still be paying 300,000 p.a to Storm for the production of containers, meaning a total yearly expenditure of about £390,000 p.a with no future machine replacement costs. This is on average £34,500 p.a less than the present cost. In five years, the company will, therefore, spend £1,950,000 (Drucker 1999).
If the company does nothing but continues with the current operations, it can be seen that the present budget of £424 500 p.a may significantly reduce in years when putron is not purchased, saving £37500, but that after four years, the machinery must be replaced at 240,000. After five years, the total expenditure, including operations and machinery replacement, will be £2,250,000. This translates to an average of £450,000 per year. It can be deduced, therefore, the CSS current operations are not the most economical option.
This scenario analyses the option that CSS should wait for the next four years before entering into contract with Storm (it is assumed that Storm’s terms will be the same after the four years).It is noted that the present putron stock will hold for the next three years and that the machinery, which can at the present be disposed at a loss of £50000 (see argument in scenario A), will need a replacement after four years.
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If the company contracts after four years, it will use £424500 this year, and £387000 that is (£424500-£37500) for the next three years (putron stocks will hold for the next 3 years), totaling £1,585,500. CSS will enter the contract in the fifth year, paying £387,500 then (which is the total annual payment for both contracts). The total for five years is, therefore, £1,973,000. The average annual expenditure would therefore be:
The table below shows a comparison of the yearly and 5 year average yearly expenses for Dailly’s department.
|Scenario||One year||Year average|
It can be concluded that the best solution for CSS would be to retain the maintenance and repair work while contracting the production of containers to Storm. If the Manager’s job in daily’s department was to be lost, however, the most economical option would be to contract both functions immediately. The second most viable consideration would be to wait until the machinery is due for the replacement and then enter into the contract.
On the other hand, it can be seen that contracting the work to Storm will lead to job loss of at least 80% of the personnel in the department with possible pension implications for senior staff, leading to losses of at least £10,000 per year (Schultz 2005). Even the most economical options will still achieve at best savings of less than £15000 per year after pensions. It is, therefore, a personal recommendation that CSS looks into ways of reducing non-essential expenses and maximizing efficiency to recover the £15,000 p.a difference as opposed to contracting, which will obviously lead to the loss of jobs (Keller 2009).