7-2. PROBLEM 7-2. Incremental Analysis of Outsourcing Decision Oakland College i
ID: 2386219 • Letter: 7
Question
7-2. PROBLEM 7-2. Incremental Analysis of Outsourcing DecisionOakland College is considering outsourcing grounds maintenance. In this regard, Oakland has received a bid from Highline Grounds Maintenance for $295,000 per year. Highline states that its bid will cover all services and planting materials required to 'keep Oakland's grounds in a condition comparable to prior years'. Oakland's cost for grounds maintenance in the preceding year were $302,000 as follows:
Salary of three full-time gardeners $195,000
Plant materials 80,000
Fertilizer 7,000
Fuel 8,000
Depreciation of tractor,mowers, and other
miscellaneous equipment 12,000
Total $302,000
If Oakland College outsources maintenance, it will be able to sell equipment for $30,000, and the three gardeners will be laid off.
Required
a. Analyze the one-year financial impact of outsourcing grounds maintenance.
b. How will savings in the second year differ from those in year 1?
c. Discuss qualitative factors that should be considered in the decision.
Explanation / Answer
Outsourcing expense
1st year
Service charges = 295,000
Fuel = 8,000
Fertilizer = 7,000
Total exp =310,000
Less: proceeds from sale of tractors, etc 30,000
Total expense would be incase of outsouricng in 1st year = 310,000 - 30,000 = 280,000
In case of self maintenace cost would be = 302,000
But depreciation is a fixed cost , therefore it should not be considered in deciding the total cost
Therefore cost in case of self maintenanace = 302,000 - 12,000
= 290,000
So we see in 1st year outsourcing would be profitable,
But in second year outsourcing would be loss making as will not get sale proceeds of tractors, etc therefore, total cost of outcourcing would be 310,000
Whereas self maintenance would be 290,000
hence from second year ownwards , outsourcing would not be favourable
In decision making, we should not consider fixed cost as fixed cost will incur even if we dont work.Hence it does not effect our cost. We should incur those costs which will be inucrred if we take that project.
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