(Plant Closing Decision) Superior-Seats Corporation manufactures seats for autom
ID: 2372363 • Letter: #
Question
(Plant Closing Decision)
Superior-Seats Corporation manufactures seats for automobiles, vans and trucks, and various recreational vehicles. The company has a number of plants around the world, including the Logger Plant (located in La Crosse, Wisconsin) that makes seat covers.
Jimmy Jones is the plant manager of the Logger Plant but also serves as the mid-west regional production manager for the company. His budget as the mid-west regional manager is charged to the Logger Plant.
Jones just heard that Superior-Seats received a bid from an outside vendor to supply the equivalent of the entire annual output of the Logger Plant for $35 million. Jones was astonished at the extremely low outside bid because the budget for the Logger Plant's operating costs for the upcoming year is set at $52 million. If this bid is accepted, the Logger Plant will be closed.
The budget for the Logger Plant's operating costs for the coming year is presented below. Additional facts regarding plant operations are as follows:
a.)
Due to Logger Plant's commitment to use high-quality fabrics in all its products, the purchasing department was instructed to place blanket purchase orders with major suppliers to ensure the receipt of sufficient materials for the coming year. If these orders were canceled as a consequence of the plant closing, termination charges would amount to 20% of the cost of direct materials.
b.)
Approximately 400 plant employees will lose their jobs if the plant is closed. This includes all of the direct laborers and supervisors as well as the plumbers, electricians, and other skilled workers classified as indirect plant workers. Some would be able to find new jobs while many others would have difficulty. All employees would have difficulty matching Logger Plant's base pay of $18.80 per hour which is the highest in the area. A clause in Logger Plant's contract with the union may help some employees; the company must provide employment assistance to its former employees for 12 months after a plant closing. The estimated cost to administer this service would be $1.5 million for the year.
c.)
Some employees would probably choose early retirement because Superior-Seats Corporation has an excellent pension plan. In fact, $3 million of the annual pension expense would continue whether the Logger Plant is open or not.
d.)
Jimmy Jones and his staff would not be affected by the closing of the Logger Plant, as they would still be responsible for administering three other area plants.
e.)
If the Logger Plant were closed, the company would realize about $3.2 million salvage value for the equipment and building. If the plant remains open, there are no plans to make any significant investments in new equipment or buildings. The old equipment is adequate and should last into the near future.
LOGGER PLANT
Annual Budget for Operating Costs
Materials $14,000,000
Labor:
Direct $13,100,000
Supervision 900,000
Indirect plant 4,000,000 18,000,000
Overhead:
Depreciation-equipment 3,200,000
Depreciation-building 7,000,000
Pension expense 5,000,000
Plant manager and staff 800,000
Corporate expenses* 4,000,000 20,000,000
Total budget costs $52,000,000
*Fixed corporate expenses allocated to plants and other operation units based on total budgeted wage and salary costs.
REQUIRED:
1.)
Superior-Seats Corporation management desires to prepare a financial analysis that will be used in deciding whether or not to close the Logger Plant. Management has asked you to identify:
a.)
The recurring annual budgeted costs that are relevant to the decision regarding closing the plant (show the dollar amounts).
b.)
The recurring annual budgeted costs that are NOT relevant to the decision regarding closing the plant, and explain why they are NOT relevant (again show the dollar amounts).
c.)
Any nonrecurring costs that would arise due to the closing of the plant, and explain how they would affect the decision (again show any dollar amounts).
2.)
Looking at the data you have prepared in (1), should the plant be closed? Show computations, and explain your answer.
3.)
Identify any revenues or costs not specifically mentioned in the problem that Superior-Seats Corporation should consider before making a decision.
Explanation / Answer
1 Continuing to obtain covers from its own Logger Cover Plant would al-low Superior-Seats(SS) to maintain its current level of control over the qualityof the covers and the timing of their delivery Keeping the Logger Cover Plant open also allows SS more flexibility than purchasing the coverings from outside suppliers SS could more easily alterthe coverings’ design and change the quantities produced, especially if long-term contracts are required with outside suppliers SS should also consider the economic impact that closing Logger Cover will have on the community and how this might affect SS’s other operations in the region
2 a The following costs can be avoided by closing the plant, and there-
fore are relevant to the decision:
Materials $14,000,000
Labor:
Direct $13,100,000
Supervision 900,000
Indirect plant 4,000,000
-------------- 18,000,000
Differential pension cost
($5,000,000 – $3,000,000) 2,000,000
----------------------------------------------
Total annual relevant costs $34,000,000
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b The following costs can’t be avoided by closing the plant, and therefore are not relevant to the decision:
Depreciation—equipment $ 3,200,000
Depreciation—building 7,000,000
Continuing pension cost 3,000,000
($5,000,000 – $2,000,000)
Plant manager and staff 800,000
Corporate allocation 4,000,000
----------------------------------------------
Total annual continuing costs $18,000,000
------------------------------------------------
Depreciation is not relevant because it represents expiration of a sunk cost Three-fifths of the annual pension expense ($3,000,000) is not relevant because it would continue whether or not the plant is closed The amount for plant manager and staff is not relevant because Jones and his staff would continue with SS and administer the three remaining plants The corporate allocation is not relevant because this represents costs incurred outside Logger Cover and as signed to the plant
c. The following nonrecurring costs would arise in the year that the plant is closed, but would not be incurred in any other year:
Termination charges on canceled material orders
($14,000,000 × 20%) $2,800,000
Employment assistance 1,500,000
----------------------------------
Total recurring costs $4,300,000
These two costs are relevant to the decision because they will be incurred only if the plant is closed
3 No, the plant should not be closed The computations are:
First Year Other Years
Cost of purchasing the covers outside $(35,000,000) $(35,000,000)
Costs avoided by closing the plant
(Part 2a) 34,000,000 34,000,000
Cost of closing the plant (1st year only) (4,300,000)
Salvage value of equipment and building 3,200,000
--------------------------------------------------------------
Net advantage (disadvantage) $ (2,100,000) $ (1,000,000)
of closing the plant
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