Relevant Cost Case Behemoth Motors Corp
Based on the background information provided for Behemoth Motors Corp (BMC), the following is a recommendation that I would give to Wally Wizard on whether or not to accept the option of Far East Enterprises Ltd (FEE) to supply the Global Positioning System Navigators (GPSN) required for all its Sports Utility Vehicles (SUVs). The two options available are; either to engage FEE to supply GPSNs (as suggested) or BMC to manufacture own GPSNs for its vehicles (under its current conditions). The option chosen should be cost effective both now and in the future of BMC. Consider the two options separately and ultimately compare the final figures (Agrawal, 2010).
According to (Jay, 2004), relevant costs or benefits are the ones that will have to be affected a decision made. In our case here, the relevant costs are:
- Cost of storage rental facility- The storage space is needed for storing the materials but it will not be needed if the GPSNs are outsourced.
- Cost incurred when 100 employees are laid off –this will be incurred if BMC decides to outsource for the units hence it will end up paying for non existence labor.
- Labor costs – these will be incurred incase the company decides to manufacture the parts in-house.
- Supervisory costs are applicable in any case – the 10 supervisors will earn $56,000 per month if the BMC decides on in-house production. The same 10 supervisors will still earn even higher $60,000 per month incase of outsourcing.
- Cost of purchasing 8,000 GPSNs per month will also be incurred if the company decides to outsource.
The only cost which remains unchanged in either cases is the General Overall cost of the company which will be incurred regardless of outsourcing or not. These costs are also known as irrelevant or avoidable costs in decision making. The company should approach Opportunity costs logically to arrive at an optimal decision (Brian, 2011).
Option A – manufacture GPSNs in house.
Option A relevant costs are: The cost of direct materials purchase, direct labor costs, the Storage space cost (rental) which would be freed if outsourced and the Supervisory cost of $56,000 per month. However, in this option the cost avoided is only the cost of layoffs (Brian, 2011).
The cost of direct materials purchase = 165 x 8000 = $ 1,320,000 per month = $15,840,000 per year. And for 2 year contract only = $31,680,000 for 2 years.
Direct labor costs = 168 x 8000 = $1,344,000 per month, = $16,128,000 per year, And for 2 year contract only = $32,256,000 for 2 years.
Storage space cost (rental) which would be freed if outsourced = 5,000 per month = 60,000 per year. And for 2 year contract only = $120,000 for 2 years. We will not consider $2.50 per sq. ft. per month per unit cost, because it is based on overall BMC factory costs.
Supervisory cost of $56,000 per month = $672,000 per year, And for 2 year contract only = $1,344,000 for 2 years.
Option B – engage FEE in supplying GPSNs
Option B relevant costs are: The cost of laying the 100 employees off, the cost of supervision and the Cost of purchasing the actual units required. In this option, the costs avoided completely are direct material costs, rental storage costs and direct labor costs (McGraw-Hill, 2013).
The cost of laying the 100 employees off: this cost spreads to a span of 4 years even if the contract of supplying GPSNs is for only 2 years with the terms stated. This means that incase the terms of contract after 2 years are unfavorable and it is there after dropped, then BMC might incur the cost of laying employees for another 2 years unnecessarily.
The cost of laying employees for 4 years = 4 x 66,000 = $ 264, 000. And even after considering a 2 year contract only the cost of layoff = $ 264, 000 for 2 years.
Supervisory cost = 6,000 x 10 = $ 60,000 per month, = $ 720,000 Per Year. And for 2 years contract only = $1,440,000 for 2 years.
Cost of purchase = 400 x 8000 = $3,200,000 per month = $38,400,000 per year and for 2 year contract only = $76,800,000 for 2 years.
Analysis of final figures and Recommendation
Considering the contract term 2 years period, option A: total costs will be = ($ 264, 000 + $1,440,000 + $76,800,000) = $78,504,000 for 2 years.
Considering the contract term 2 years period, option B: total costs will be = ($31,680,000 + $32,256,000 + $120,000 + $1,344,000 + $15,360,000) = $65,400,000 for 2 years.
Therefore, for the contract term of 2 years, Option B $65,400,000 is better than Option A with a total cost of $78,504,000 after a penalty of $264,000 has been paid for the 4 years.
Under the current conditions of the FEE’s contract of 2 years, I would recommend BMC to do in-house manufacturing of GPSNs rather outsource because the total cost will be more in outsourcing even though the unit cost seems to be cheaper than own made units (McGraw-Hill, 2013).
Agrawal, N. K. (2010). Principles of Management Accounting, Global Media.
Jay, B., (2004). Relevant costs for decision-making, accessed, 19 July 2013, http://www.accountancy.com.pk/articles_students.asp?id=142
McGraw-Hill, accessed, 19 July 2013, http://www.mcgrawhill.ca/college/larson9/olc/olc/graphics/larson9fa_s/ch28/slideshows/sld030.htm