Chapter 04 -Fundamentals of Cost Analysis for Decision Making
4-51
4-62. (continued)
Alternative A
Alternative B
Alternative C
Alternative D
Make
Containers;
Perform
Maintenance
Make
Containers; Buy
Maintenance
Buy Containers;
Perform
Maintenance
Buy Containers;
Buy
Maintenance
NPV ($)
$ (2,735,502)
$ (3,082,945)
$ (2,619,684)
$ (2,712,251)
c. Although Alternative C seems to be the more attractive, its net present value is not
significantly different from the net present values of Alternatives A and D. This
situation requires a careful examination of facts and assumptions made. A brief
discussion of some points that should be reevaluated, as well as additional information
that should be taken into account, is presented below.
Administrative Overhead: A proportion of general administrative overhead is allocated
to the container department. Is this cost proportional to the number of employees in
the container department? Apparently the answer is yes, and in this case it is not the
best estimate because it is not considering the real administrative resources consumed
by the container department.
Quality of Outsource Services: Quality issues are always important when a company
is considering outsourcing some services. In this case, it is assumed that Packages,
Inc. will perform maintenance and/or make containers with a quality at least as good as
Liquid Chemical’s quality. Due to the importance of quality, Liquid Chemical Co.
should carefully evaluate Package Inc.’s ability to meet quality requirements imposed
by Liquid Chemical.
Container Contract Terms: Does Packages Inc. have the ability to meet Liquid
Chapter 04 -Fundamentals of Cost Analysis for Decision Making
4-52
4-62. (continued)
Year of Operation
0
1
2
3
4
5
Buy GHL
$(240,000)
Tax savings on purchase (40%)
$96,000
Cash flow on purchase
$(144,000)
Other materials
$(500,000)
$(500,000)
$(500,000)
$(500,000)
$(500,000)
Labor: Supervisor
(50,000)
(50,000)
(50,000)
(50,000)
(50,000)
Labor: Workers
(450,000)
(450,000)
(450,000)
(450,000)
(450,000)
Rent: Warehouse
(85,000)
(85,000)
(85,000)
(85,000)
(85,000)
Maintenance
(36,000)
(36,000)
(36,000)
(36,000)
(36,000)
Other expenses
(157,500)
(157,500)
(157,500)
(157,500)
(157,500)
Manager’s salary
(80,000)
(80,000)
(80,000)
(80,000)
(80,000)
Total costs
$(1,358,500)
$(1,358,500)
$(1,358,500)
$(1,358,500)
$(1,358,500)
Tax savings (40%)
543,400
543,400
543,400
543,400
543,400
Cash flow due to costs
$(815,100)
$(815,100)
$(815,100)
$(815,100)
$(815,100)
Tax effects of depreciation
60,000
60,000
60,000
60,000
–
Tax effect of GHL costs
80,000
80,000
80,000
80,000
–
Total cash flow
$(675,100)
$(675,100)
$(675,100)
$(675,100)
$(959,100)
Discount rate factor (10%)
1.0000
0.9091
0.8264
0.7513
0.6830
0.6209
Present value
$(613,727)
$(557,934)
$(507,213)
$(461,102)
$(595,526)
NPV
$(2,735,502)
Chapter 04 -Fundamentals of Cost Analysis for Decision Making
4-53
4-62. (continued)
Considerations (Alternative A):
X 40%) from Year 1 to Year 4.
Chapter 04 -Fundamentals of Cost Analysis for Decision Making
4-54
4-62. (continued)
Year of Operation
0
1
2
3
4
5
Buy GHL
$(120,000)
Tax savings on purchase (40%)
$48,000
Cash flow on purchase
$(72,000)
Other materials
$(450,000)
$(450,000)
$(450,000)
$(450,000)
$(450,000)
Labor: Supervisor
(50,000)
(50,000)
(50,000)
(50,000)
(50,000)
Labor: Workers
(360,000)
(360,000)
(360,000)
(360,000)
(360,000)
Rent: Warehouse
(85,000)
(85,000)
(85,000)
(85,000)
(85,000)
Maintenance
(36,000)
(36,000)
(36,000)
(36,000)
(36,000)
Other expenses
(92,500)
(92,500)
(92,500)
(92,500)
(92,500)
Manager’s salary
(80,000)
(80,000)
(80,000)
(80,000)
(80,000)
Maintenance contract
(375,000)
(375,000)
(375,000)
(375,000)
(375,000)
Total costs
$(1,528,500)
$(1,528,500)
$(1,528,500)
$(1,528,500)
$(1,528,500)
Tax savings (40%)
611,400
611,400
611,400
611,400
611,400
Cash flow due to costs
$(917,100)
$(917,100)
$(917,100)
$(917,100)
$(917,100)
Tax effects of depreciation
60,000
60,000
60,000
60,000
–
Tax effect of GHL costs
72,000
72,000
72,000
72,000
32,000
Total cash flow
$(785,100)
$(785,100)
$(785,100)
$(785,100)
$(957,100)
Discount rate factor (10%)
1.0000
0.9091
0.8264
0.7513
0.6830
0.6209
Present value
$(713,727)
$(648,843)
$(589,857)
$(536,234)
$(594,284)
NPV
$(3,082,945)
Chapter 04 -Fundamentals of Cost Analysis for Decision Making
4-55
© 2014 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned,
duplicated, forwarded, distributed, or posted on a website, in whole or part.
4-62. (continued)
Considerations (Alternative B):
Under this alternative, GHL consumption is 36 tons per year (= 40 X 90%). At the end of Year 4 the GHL stock is
16 tons, and a purchase of 20 tons is necessary. At that time, the price will be $6,000 per ton.
Due to lower GHL consumption, during Year 5 there is still an “accounting” expense of $80,000 (= 16 tons X
Chapter 04 -Fundamentals of Cost Analysis for Decision Making
4-56
4-62 (continued)
Year of Operation
0
1
2
3
4
5
Sell machinery
$200,000
Tax savings on sale (40%)
160,000
Cash flow on sale
$360,000
Sell GHL
$560,000
Tax savings on sale (40%)
56,000
Cash flow on sale
$616,000
Other materials
$(50,000)
$(50,000)
$(50,000)
$(50,000)
$(50,000)
Labor: Supervisor
(50,000)
(50,000)
(50,000)
(50,000)
(50,000)
Labor: Workers
(90,000)
(90,000)
(90,000)
(90,000)
(90,000)
Rent: Warehouse
(85,000)
(85,000)
(85,000)
(85,000)
(85,000)
Severance pay
$(16,000)
–
–
–
–
–
Other expenses
(65,000)
(65,000)
(65,000)
(65,000)
(65,000)
Manager’s salary
–
–
–
–
–
Container contract
$-
(1,250,000)
(1,250,000)
(1,250,000)
(1,250,000)
(1,250,000)
Total costs
$(16,000)
$(1,590,000)
$(1,590,000)
$(1,590,000)
$(1,590,000)
$(1,590,000)
Tax savings (40%)
6,400
636,000
636,000
636,000
636,000
636,000
Cash flow due to costs
$(9,600)
$(954,000)
$(954,000)
$(954,000)
$(954,000)
$(954,000)
Tax effects of depreciation
–
–
–
–
–
Tax effect of GHL costs
8,000
8,000
8,000
8,000
8,000
Total cash flow
$966,400
$(946,000)
$(946,000)
$(946,000)
$(946,000)
$(946,000)
Discount rate factor (10%)
1.0000
0.9091
0.8264
0.7513
0.6830
0.6209
Present value
$966,400
$(860,000)
$(781,818)
$(710,744)
$(646,131)
$(587,392)
NPV
$(2,619,685)
Chapter 04 -Fundamentals of Cost Analysis for Decision Making
4-57
4-62 (continued)
Considerations (Alternative C):
Under this alternative, GHL consumption is 4 tons per year (40 X 10%), or 20 tons over five years. Therefore,
Liquid Chemical can sell 140 tons (= 160 – 20) at the end of Year 0 at $4,000 per ton.
Chapter 04 -Fundamentals of Cost Analysis for Decision Making
4-58
4-62 (continued)
Year of Operation
0
1
2
3
4
5
Sell machinery
$200,000
Tax savings on sale
160,000
Cash flow on sale
$360,000
Sell GHL
$640,000
Tax savings on sale (40%)
64,000
Cash flow on sale
$704,000
Other materials
$-
$-
$-
$-
$-
Labor: Supervisor
–
–
–
–
–
Labor: Workers
–
–
–
–
–
Rent: Warehouse
–
–
–
–
–
Severance pay
$(20,000)
–
–
–
–
–
Pension
(30,000)
(30,000)
(30,000)
(30,000)
(30,000)
Other expenses
–
–
–
–
–
Manager’s salary
–
–
–
–
–
Container contract
(1,250,000)
(1,250,000)
(1,250,000)
(1,250,000)
(1,250,000)
Maintenance contract
$-
(375,000)
(375,000)
(375,000)
(375,000)
(375,000)
Total costs
$(20,000)
$(1,655,000)
$(1,655,000)
$(1,655,000)
$(1,655,000)
$(1,655,000)
Tax savings (40%)
8,000
662,000
662,000
662,000
662,000
662,000
Cash flow due to costs
$(12,000)
$(993,000)
$(993,000)
$(993,000)
$(993,000)
$(993,000)
Tax effects of depreciation
–
–
–
–
–
Tax effect of GHL costs
–
–
–
–
–
Total cash flow
$1,052,000
$(993,000)
$(993,000)
$(993,000)
$(993,000)
$(993,000)
Discount rate factor (10%)
1.0000
0.9091
0.8264
0.7513
0.6830
0.6209
Present value
$1,052,000
$(902,727)
$(820,661)
$(746,056)
$(678,232)
$(616,575)
NPV
$(2,712,251)
Chapter 04 -Fundamentals of Cost Analysis for Decision Making
4-59
4-62 (continued)
Considerations (Alternative D):
Under this alternative, there is no GHL consumption. Therefore, Liquid