Chapter 11 – Decision Making with a Strategic Emphasis
11–46
11-35 (Continued-2)
Re: The purchase of attic fans from Harris Products:
• What are the alternative uses of Martens’ production capacity, in
addition to pumps and attic fans that might produce higher
contribution?
• How reliable is Martens’ information that Harris is a reliable producer
of quality products?
• How will Martens’ customers react, if at all, to know that the attic fans
are not manufactured by Martens?
11–47
11–36 Make or Buy; Strategy (30 min)
1. GianAuto is in a high-growth, highly competitive industry. Auto makers
are increasingly outsourcing the manufacture of parts and entire brake
or seating systems to low-cost producers throughout the world. In
North America, many of these plants are located in Mexico and
throughout Latin America. To be competitive in this business, Gian
must continue to be cost competitive and to also provide the customer
service and reliability that is expected by the auto makers. Gian can
coverings from outside suppliers. GianAuto could more easily alter the
coverings’ design and change the quantities produced, especially if
long term contracts are required with outside suppliers. GianAuto
should also consider the economic impact that closing Denver Cover
will have on the community and how this might affect GianAuto’s other
operations in the region.
Chapter 11 – Decision Making with a Strategic Emphasis
11–48
Other items that should be considered by GianAuto before making a
decision include:
• The disposal value or alternate uses of the plant and equipment.
• Any income tax implications including tax rates applicable to
• Should GianAuto continue to manufacture the covers, but in a
new, cost-efficient plant; the location could be anywhere in the
world.
Chapter 11 – Decision Making with a Strategic Emphasis
11–49
11-36(continued-1)
2. The net cost savings from closing the plant are estimated as $55,200,
as follows:
Gross Cost Savings (Cost Avoided)
Materials $32,000
Labor
Additional Plant-Closing Charges
Termination charges on cancelled material orders
($32,000 × 0.15) 4,800
Employment assistance 1,000
Total $68,800
Net relevant costs (savings to close the plant) $55,200
The following costs are not relevant to the decision since they are
unavoidable costs:
Depreciation-equipment $5,000
Depreciation-building 3,000
Continuing pension expense
• The depreciation amounts are not relevant to the decision
because they represent portions of sunk costs that are being
written off during 2013.
• Three-fourths of the annual pension expense ($3,000) is not
relevant because this amount would continue whether or not the
plant is closed.
Chapter 11 – Decision Making with a Strategic Emphasis
11–50
11-36 (Continued-2)
• The amount for plant manager and staff is not relevant because
Vosilo and his staff would continue with GianAuto and administer
three remaining plants.
with an associated increased demand for automobiles. Also, the company
needs to consider how the cost of outsourcing production might change as
a result of the current difficult economic times. Will wage rates in the U.S.
fall relative to other countries to make the Denver plant more competitive?
If so, then closing the plant at this time might be unwise, irrespective of the
analysis of costs; the company would then need the plant for future low-
cost production. The analysis of the decision regarding the Denver plant
requires a complex and comprehensive consideration of global economic
trends as well as the costs in the plant itself.
Chapter 11 – Decision Making with a Strategic Emphasis
11–51
11–37 Make or Buy; Strategy; Ethics (45 min)
1. An analysis of per unit and total costs for 32,000 units shows that the
Midwest Division should purchase the parts for a saving of $15,440
($575,040 − $559,600).
Cost per unit
Total Cost
Cost to purchase MTR-2000 from Marley:
Bid price from Marley
$17.3000
$553,600
Equip. lease penalty [($36,000÷12) × 2 × 1]
0.1875
6,000
Total cost to purchase
$17.4875
$559,600
Cost for Midwest to Make MTR-2000:
Direct material ($195,000 ÷ 30,000) × 1.08
7.02
$224,640
Direct labor ($120,000 ÷ 30,000) × 1.05
4.20
134,400
Factory space rental ($84,000 ÷ 32,000)*
2.625
84,000
Equipment leasing ($36,000 ÷ 32,000)*
1.125
36,000
Variable manufacturing overhead
3.00
96,000
Total cost to make
$17.97
$575,040
*Total production required in 2013 is 32,000 units; 30,000 units in
2012. Unit variable costs are based on 2012 costs and units; fixed
costs in total are the same in 2013 as in 2012.
2. Strategic factors that the Midwest Division and Paibec Corporation
should consider before agreeing to purchase MTR-2000 from Marley
Company include the following:
• The quality of the Marley component should be equal to, or better
than, the quality of the internally made component, or else the
labor problems or affect the company’s position in the community,
In addition, there may be termination costs which have not been
factored into the analysis.
11–52
11–37 (continued)
3. Referring to the specific standards for ethical practice by a
management accountant
(http://www.imanet.org/PDFs/Statement%20of%20Ethics_web.pdf),
Lynn Hardt should consider the ethical standards of competence,
integrity, and objectivity:
Competence
• Prepare complete and clear reports and recommendations after
appropriate analysis of relevant and reliable information. John has
asked Lynn to adjust and falsify her report and leave out some
manufacturing overhead costs.
Integrity
• Refrain from either actively or passively subverting the attainment
of the organization’s legitimate and ethical objectives, Paibec has
a legitimate objective of trying to obtain the component at the
• Refrain from engaging in or supporting any activity that would
discredit the profession. Falsifying the analysis would discredit
Hardt and the profession.
Credibility
• Communicate information fairly and objectively. Hardt needs to
to fully disclose the analysis and the expected cost increases.
Chapter 11 – Decision Making with a Strategic Emphasis
11–53
11–38 Outsourcing Call Centers (40 min)
1. The corporate overhead cost is irrelevant since in total it will not
change whether or not the call center is returned to Atlanta (i.e., it is
not an avoidable cost).
Naftel
Present Value
Annual Costs First 3 Yrs Yrs 4-5 Factor (6%) Naftel Atlanta
Naftel Contract 4,200,000$ – – 4.21200 17,690,400$
Lease Opportunity cost, Yr 4 – – 100,000$ 0.79209 – 79,209$
Lease Opportunity cost, Yr 5 – 100,000 0.74726 – 74,726
Salaries – $2,300,000 2,300,000 4.21236 – 9,688,437
Equipment (leased) – $850,000 850,000 4.21236 – 3,580,509
Telecommunications – $500,000 500,000 4.21236 – 2,106,182
Administrative – $600,000 600,000 4.21236 – 2,527,418
Naftel, per-year amount 4,200,000$ 17,690,400$
Present Value
Atlanta
discount the amounts applicable to all five years, while single sum discount
factors are used for the lease opportunity cost in years 4 and 5 (0.792 and
0.747 for Year 4 and Year 5, respectively). The present value tables are
located at the end of Chapter 12. (NOTE: the results reported above are
based on exact present-value factors; if the factors from the text, which are
rounded, are used, the answer will be slightly different from that presented
above.)
The analysis shows that the Naftel contract would save MB $50,000 per
year in each of the first three years, and $150,000 in each of years 4 and 5.
Whether you consider the undiscounted or the present-value analysis, it is
clear that the Naftel contract has the lower cost. But, the difference is not
great relative to total cost, so that strategic issues are important in making
the final decision. Some of these strategic issues are discussed in parts 2
and 3 below. In addition:
11–54
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11-38 (continued)
• Since customer service is very important for MB’s success,
would the location of the call center in Atlanta or at Naftel provide
• Given the difficult times predicted (at the time) for the banking
industry, would it not have been especially important to
differentiate the company from others? Customer service is one
important way to do that. If customer service in Atlanta could be
carefully managed so that it provides very high quality service,
this could be an important competitive advantage.
2. At the time of the decision (late 2008), the value of the dollar had
been increasing relative to most other currencies. This means that
the cost to MB of the service by Naftel would decrease in currency–
services as MB grows.
3. The ethical issues in the decision here include the consideration of a
community obligation that MB has for providing jobs, when possible,
in a local economy that had been suffering from high unemployment.
11–39 Budgeting and Sustainability (60-75 minutes) (note: this is Pr. 10–58)
Requirement 1: Short-Term Financial Analysis
For purposes of illustration (and for Requirement 3 below), the cell
reference for $13,125 (above) is G24; the cell reference for $60,000
(above) is G14.
Requirement #2: Assume the Switch to the New Compound and the Introduction of Continuous-
Improvement (Kaizen) Budgeting
Estimated increase in processing cost, per year with new compound (from above) =
$73,125
Estimated annual cost savings, per Kaizen budget:
Original Monthly Processing Costs (other than materials):
Commercial:
Labor ($4.00/batch x 7,500 batches/year ÷ 12 months/year) $2,500.00
Electricity ($1.50/batch x 7,500 batches/year ÷ 12 months/year) $937.50
Individual:
Labor ($4.00/batch x 3,000 batches/year ÷ 12 months/year) $1,000.00
Electricity ($1.00/batch x 3,000 batches/year ÷ 12 months/year) $250.00
Chapter 11 – Decision Making with a Strategic Emphasis
Cell references: $73,125 = cell G32 (=G23); $4,687.50 = cell G42 (=SUM(G37:G41));
$56,250.00 = cell G43.
11–39 (Continued–1)
Revised Level of Monthly Processing Costs (other than materials):
Month Labor Electricity
1 $3,465.00 $1,175.63
2 $3,430.35 $1,163.87
3 $3,396.05 $1,152.23
4 $3,362.09 $1,140.71
5 $3,328.47 $1,129.30
6 $3,295.18 $1,118.01
7 $3,262.23 $1,106.83
8 $3,229.61 $1,095.76
9 $3,197.31 $1,084.80
10 $3,165.34 $1,073.95
11 $3,133.68 $1,063.21
12 $3,102.35 $1,052.58
Total–-Yr. 1 $39,367.64 $13,356.88 $52,724.52
Chapter 11 – Decision Making with a Strategic Emphasis
11–57
11–39 (Continued–2)
Requirement 3
a. Determine the Monthly Cost-Reduction Rate that would Equate the net increase in year-one total
processing costs (materials + labor + electricity) with the anticipated fine
Step One: Define the Breakeven Cost Equation
Difference between the fine and net increase in year-one processing costs $9,599.52
Step Two: Run Goal Seek
breakeven level: that is, the rate of monthly cost savings needed to equate the
value of the fine and the increased processing costs due to the new compound, but
after implementing Kaizen. As shown below, Goal Seek provides the answer:
4.164% per month.
Chapter 11 – Decision Making with a Strategic Emphasis
11–58
Step Three: Solution
In other words, in order to be indifferent between incurring the fine ($60,000) and incurring extra
processing costs per year, after implementing Kaizen budgeting, the monthly rate of cost decrease
must be 4.164%. At this level, the year-one Kaizen-based cost savings would be $13,125, while the net
year-one processing cost increase would be $60,000 ($73,125 – $13,125)--an amount exactly equal to
the estimated fine. Note, however, that such a dramatic increase in productivity is highly questionable.
b. The cost per pound for the new compound that would equate the anticipated fine with
the net year-one costs, assuming no Kaizen budgeting plan (i.e., no reduction per
month in processing costs):
11–39 (Continued–3)
Step One: Set Up the Cost Equation
Cost differential: anticipated fine and net one-year processing costs, with
no Kaizen budgeting plan = $13,125
Note: the above value is contained (in this example) in cell G99, which
in turn is defined as the contents from cell G24. G24 contains the
difference between the anticipated cost of the fine, $60,000 (entered in
cell G14) and the expected increase in material cost associated with the
use of the new compound (G23), as shown below:
Chapter 11 – Decision Making with a Strategic Emphasis
11–59
Step Two: Run Goal Seek
Cell E8 contains the cost of the new compound, per pound of laundry; cell
G99 contains the cost difference: the anticipated fine versus the increased
processing cost attributable to the use of the new compound.
11–39 (Continued–4)
Step 3: Results
other changes, then the owner would be indifferent between incurring
the estimated fine and using the new (higher-priced) compound. Of
course, other considerations may affect the ultimate decision.
4. Operational Changes Needed to Ensure Kaizen Cost Savings
The reduction in labor time might be realized by improving the efficiency
of operations, including a decrease in machine downtime. It is probably
Chapter 11 – Decision Making with a Strategic Emphasis
11–60
To achieve aggressive cost reductions in labor, however, it might be
necessary to institute some type of employee incentive program.
Savings in electricity consumption may be more difficult to achieve.
Some reduction would likely accompany any planned-for reductions in
chain. David Duncan is more likely to achieve his cost-reduction goals
by working with his suppliers. As indicated above, if the cost of the new
compound can be decreased by only $0.25 per pound of laundry
processed, David would be indifferent (solely on an expected cost basis)
11–39 (Continued-5)
5. Other (qualitative) Considerations that Might Affect the Ultimate
Decision:
• What impact, perhaps negative, will the Kaizen budgeting approach
have on employee morale?
• Will the quest to achieve aggressive levels of cost reduction have a
negative effect on service quality?
• Will the use of the new, environmentally friendly cleaning compound
have a beneficial effect on the image of the business and therefore
on sales?
• Would the use of the new cleaning compound have a beneficial
impact on employee health/working conditions?
• If the existing cleaning compound were to continue to be used, would
it require any special handling costs/preventative measures (e.g.,
employee health and safety)?
• Would incurring a fine (rather than incurring increased operating
costs) negatively affect the image of the business, and therefore