A business places substantial emphasis on customer satisfaction and, to this end, delivers itsproduct in special protective containers. These containers have been made in a departmentwithin the business. Management has recently become concerned that this internal supply ofcontainers is very expensive. As a result, outside suppliers have been invited to submit tendersfor the provision of these containers. A quote of £250,000 a year has been received for avolume that compares with current internal supply.An investigation into the internal costs of container manufacture has been undertaken andthe following emerges:(i) The annual cost of material is £120,000, according to the stores records maintained, atactual historic cost. Three-quarters (by cost) of this represents material that is regularlystocked and replenished. The remaining 25 per cent of the material cost is a special foamingchemical that is not used for any other purpose. There are 40 tonnes of this chemicalcurrently held. It was bought in bulk for £750 a tonne. Today’s replacement price for thismaterial is £1,050 a tonne but it is unlikely that the business could realise more than £600a tonne if it had to be disposed of owing to the high handling costs and special transportfacilities required.(ii) The annual labour cost is £80,000 for this department; however, most are casual employeesor recent starters, and so, if an outside quote were accepted, little redundancy would bepayable. There are, however, two long-serving employees who would each accept as asalary £15,000 a year until they reached retirement age in two years’ time.(iii) The department manager has a salary of £30,000 a year. The closure of this departmentwould release him to take over another department for which a vacancy is about to beadvertised. The salary, status and prospects are similar.(iv) A rental charge of £9,750 a year, based on floor area, is allocated to the containers department.If the department were closed, the floor space released would be used for warehousingand, as a result, the business would give up the tenancy of an existing warehousefor which it is paying £15,750 a year.(v) The plant cost £162,000 when it was bought five years ago. Its market value now is £28,000and it could continue for another two years, at which time its market value would have fallento zero. (The plant depreciates evenly over time.)(vi) Annual plant maintenance costs are £9,900 and allocated general administrative costs£33,750 for the coming year.Required:Calculate the annual cost of manufacturing containers for comparison with the quote usingrelevant figures for establishing the cost or benefit of accepting the quote. Indicate any assumptionsor qualifications you wish to make.
