Reference no: EM131120087

A business places substantial emphasis on customer satisfaction and, to this end, delivers its product in special protective containers. These containers have been made in a department within the business. Management has recently become concerned that this internal supply of containers is very expensive. As a result, outside suppliers have been invited to submit tenders for the provision of these containers. A quote of £250,000 a year has been received for a volume that compares with current internal supply. An investigation into the internal costs of container manufacture has been undertaken and the following emerges:

(a) The annual cost of material is £120,000, according to the stores records maintained, at actual historic cost. Three-quarters (by cost) of this represents material that is regularly stocked and replenished. The remaining 25 per cent of the material cost is a special foaming chemical that is not used for any other purpose. There are 40 tonnes of this chemical currently held. It was bought in bulk for £750 a tonne. Today's replacement price for this material is £1,050 a tonne but it is unlikely that the business could realise more than £600 a tonne if it had to be disposed of owing to the high handling costs and special transport facilities required.

(b) The annual labour cost is £80,000 for this department. Most, however, are casual employees or recent starters, and so, if an outside quote was accepted, therefore, little redundancy would be payable. There are, however, two long-serving employees who would each accept as a salary £15,000 a year until they reached retirement age in two years' time.

(c) The department manager has a salary of £30,000 a year. The closure of this department would release him to take over another department for which a vacancy is about to be advertised. The salary, status and prospects are similar.

(d) 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 warehousing and, as a result, the business would give up the tenancy of an existing warehouse for which it is paying £15,750 a year.

(e) The plant cost £162,000 when it was bought five years ago. Its market value now is £28,000 and it could continue for another two years, at which time its market value would have fallen to zero. (The plant depreciates evenly over time.)

(f) 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 using relevant figures for establishing the cost or benefit of accepting the quote. Indicate any assumptions or qualifications you wish to make.