1. Fast Finish, Inc. (FFI) has made a technological breakthrough in snow board finish application. FFI will apply the finish for $0.23 per unit in variable costs plus a fixed annual cost of $230,000. Use the cost and demand information given in Problem 3 for Downhill Boards to evaluate this proposal.

(a) What will it cost Downhill Boards to outsource the finishing process?
(b) At what demand level does it make sense economically to outsource the finishing process?
(c) What additional factors should be considered when making this outsourcing decision?

2. Cal's Carpentry is considering outsourcing its accounts receivable function. Currently, Cal employs two full-time clerks and one part-time clerk to manage accounts receivable. Each full-time clerk has an annual salary of $36,000 plus fringe benefits costing 30 percent of their salary. The part-time clerk makes $18,000 per year but has no fringe benefits. Total salary plus fringe cost is $111,600. Cal estimates that each account receivable incurs a $10 variable cost. The Small Business Accounts Receivables Group (SBARG) specializes in handling accounts receivable for small- to medium-size companies. Doris Roberts from SBARG has offered to do the accounts receivable for Cal's Carpentry at a fixed cost of $75,000 per year plus $30 per account receivable. Next year, Cal expects to have 2000 accounts receivable.

(a) Calculate the cost for Cal's Carpentry to continue doing accounts receivable in-house.

(b) Calculate the cost for Cal's Carpentry to use SBARG to handle the accounts receivable.

(c) If the fixed annual cost offered by SBARG is nonnegotiable but it is willing to negotiate the variable cost, what variable cost from SBARG would make Cal indifferent to the two options?

Solved Problems

Problem 1

Jack Smith, owner of Jack's Auto Sales, is deciding whether his company should process its own auto loan applications or outsource the process to Loans Etc. If Jack processes the auto loan applications internally, he faces an annual fixed cost of $2500 for membership fees, allowing him access to the Top-Notch credit company, and a variable cost of $25 each time he processes a loan application. Loans Etc. will process the loans for $35 per application, but Jack must lease equipment from Loans Etc. at a fixed annual cost of $1000. Jack estimates processing 125 loan applications per year. What do you think Jack should do?

(a) Should Jack process the loans internally or outsource the loans if demand is expected to be 125 loan applications?
(b) Is Jack indifferent to internal processing and outsourcing at one level of loan applications?

Before You Begin

To make his decision when demand is known, Jack needs to calculate the total cost of processing the auto loans in-house and compare it to the total cost of outsourcing the loan processing. You need to identify the relevant costs. If Jack processes the loans internally, he has an annual fixed cost of $2500 plus a per loan variable cost of $25. If the loan processing is outsourced, Jack has a fixed annual cost of $1000 and a per loan variable cost of $35.

Problem 2

Big State University (BSU) is considering whether or not it should outsource its housekeeping service. Currently, BSU employs 400 housekeepers at an average annual wage of $23,000 plus another 39 percent for fringe benefits. Annual fixed costs associated with housekeeping are $1,278,800.

Eric's Efficient Cleaners (EEC) will provide similar housekeeping for a fixed annual cost of $7,500,000 plus a variable cost of $20,000 per housekeeper required. Because Eric uses state-of-the-art equipment and well-trained employees, his company would need only 80 percent of the current BSU housekeeper staff (or 320 housekeepers).

(a) Calculate the annual cost of BSU using its current housekeeping staff.
(b) Calculate the annual cost if BSU lets EEC do the housekeeping.
(c) Find the indifference point for the two alternatives.

Before You Begin:

Identify the relevant costs. You need to know the cost to BSU for using its own housekeeping staff. The average annual salary per housekeeper is $23,000 plus fringe benefits (39 percent of the average annual salary). The annual fixed cost associated with housekeeping is $1,278,800. If housekeeping is outsourced, BSU doesn't need to pay fringe benefits. EEC will provide similar service for a fixed annual cost of $7,500,000 plus a variable cost of $20,000 per housekeeper. Remember that he only needs 320 housekeepers for the job.