X Company is considering outsourcing its email system. Total costs related to la
ID: 2463454 • Letter: X
Question
X Company is considering outsourcing its email system. Total costs related to last month's in-house email operation, when there were 3,940 employee mailboxes, were as follows: Variable costs:
Email license $23,640
Virus protection license 7,880
Miscellaneous 11,820
Fixed costs Computer hardware 27,580
$12,135 of the computer hardware costs were common costs that will continue even if the email system is abandoned, and X Company will still need to pay for the virus protection license. Y Company has offered to operate an email system for X Company for $13.60 per mailbox. Next year, X Company estimates that 4,125 mailboxes will be required per month. By how much will X Company's monthly profits change if they decide to outsource its email function to Y Company instead of managing the service internally? [A positive number means that make costs are more than buy costs; a negative number means that make costs are less than the buy costs.]
Explanation / Answer
Answer:
The problem is related to Make or Buy Decision. In this case the decision should be taken based on relevant cost for making product or relevant cost for buying product from outside. The costs which are common under both the situations should be ignored (i.e. not considered) while taking the decision for make or buy the product.
First we calculated Variable Cost Per Email Operation from Last month (data given in the question)
Total Cost related to last month (In-House email operation -- 3,940 Employees)
Cost Per Email Operation
Variable Cost:
Email License
$23,640
$6.00
Virus Protection License
$7,880
$2.00
Miscellaneous
$11,820
$3.00
Fixed Costs Computer Hardware
$27,580
Total Cost
$70,920
Now, the next year, Company estimates Mailboxes per month = 4,125
In this situation, first of all we need to calculate the In-House Email operation Cost for next year based on 4,125 Email Operations in month as follows:
Total Cost of month related to next year (In-House email operation -- 4,125 Employees)
Cost Per Email Operation
Variable Cost:
Email License
$24,750
$6.00
Virus Protection License
$8,250
$2.00
Miscellaneous
$12,375
$3.00
Fixed Costs Computer Hardware
$27,580
Total Cost
$72,955
Now, we need to calculate the Total Cost if Email Operations are Outsource for 4,125 Employees as follows:
Total Cost of month related to next year (Outsourcing of Email Operations -- 4,125 Employees)
Cost Per Email Operation
Variable Cost:
Operating Cost for email system
$56,100
$13.60
Virus Protection License
$8,250
$2.00
Total Cost
$64,350
From the above calculations, it is clear that Virus Protection License Cost is common in In-House Operation and Outsource of Operations. Hence it can be ignored while making a choice between In house operation and Outsource operation.
Now we need to prepare a Comparative Cost Statement for In-House Operation Management and Outsource Operation as follows:
Comparative Cost Statement for Next Year (Email Operation - 4,125 Employees Per Month)
In-House Operation Cost
Outsource Operation Cost
Variable Cost:
Email License
$24,750
Operating Cost for email system (Outsource)
$56,100
Virus Protection License (note 1)
Miscellaneous
$12,375
Unavoidable Fixed Cost - Computer Hardware (note 2)
$12,135
Total Cost
$49,260
$56,100
Note 1 – Company will still need to pay Virus Protection License cost whether the company will do In House Operation or outsource the operation. Since this cost is common under both the option. It is not treated as relevant cost for decision making. Hence it is ignored. The costs which are common under each alternative course of action is IRRELEVANT Cost and should be ignored in decision making.
Note 2--- In the question it is given that $12,135 Computer Hardware Costs were common costs that will continue even if the email system is abandoned. It means if the In-House system abandoned this cost will continue to incur to the company. Hence it is relevant for decision making.
Analysis:
From the above Comparative Cost Statement it is clear that the cost of managing In-House Operation of Email System is less than outsourcing it. If Company go for Outsourcing the Email System it will incur additional cost of $6,840 ($56,100 - $49,260). In other words, company’s profit will be decreased by $6,840 if they go for outsourcing of Email system.
Therefore, X Company’s monthly profits will be decreased by $6,840 if they decide to outsource its email function to Y Company instead of managing the service internally.
Answer is -$6,840
Total Cost related to last month (In-House email operation -- 3,940 Employees)
Cost Per Email Operation
Variable Cost:
Email License
$23,640
$6.00
Virus Protection License
$7,880
$2.00
Miscellaneous
$11,820
$3.00
Fixed Costs Computer Hardware
$27,580
Total Cost
$70,920
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