Automotive Interiors (AI) manufactures seats for automobiles, vans, trucks, and

Question

Automotive Interiors (AI) manufactures seats for automobiles, vans, trucks, and boats. The company has a number of plants, including the Woodstock Cover Plant, which makes seat covers.

Bill Rice is the plant manager at the Woodstock Cover Plant but also serves as the regional production manager for the company. His budget as the regional manager is charged to the Woodstock plant.

Rice has just heard that AI has received a bid from an outside vendor to supply the equivalent of the entire annual output of the Woodstock Cover Plant for $42 million. Rice was astonished at the low outside bid because the budget for the plant's operating costs for the coming year was set at $48.6 million. If this bid is accepted, the Woodstock operation will be closed down.

The budget for the Woodstock Cover Plant's operating costs for the coming year is presented below:

d

The following are additional facts regarding the plant's operations:

Page 570

Due to the plant's commitment to use high-quality fabrics in all of 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 cancelled as a consequence of the plant closing, termination charges would amount to 25% of the cost of direct materials.

Approximately 350 employees would lose their jobs if the plant were closed. This includes all of the direct labourers and supervisors; management and staff; and the plumbers, electricians, and other skilled workers classified as indirect plant workers. Some of these workers would have difficulty finding new jobs. Nearly all of the production workers would have difficulty matching the plant's base pay of $12.50 per hour, which is the highest in the area. A clause in the plant's contract with the union may help some employees; the company must provide employment assistance and job training to its former employees for 12 months after a plant closing. The estimated cost to administer this service would be $1.6 million.

Some employees would probably choose early retirement because AI has an excellent pension plan. In fact, $1.4 million of the annual pension expenditures would continue whether the plant is open or not.

Rice and his regional staff would not be affected by the closing of the Woodstock plant. They would still be responsible for running three other area plants.

If the plant were closed, the company would realize about $4 million salvage value for the equipment in the plant. If the plant remained open, there would be no plans to make any significant investments in new equipment or buildings. The old equipment is adequate for the job and should last indefinitely.

Required:

1. Without regard to costs, identify the advantages to AI of continuing to obtain covers from its own Woodstock Cover Plant.

2. AI plans to prepare a financial analysis that will be used in deciding whether or not to close the Woodstock Cover Plant. Management has asked you to identify the following:

a) The annual budgeted costs that are relevant to the decision regarding closing the plant (show the dollar amounts).

b) The annual budgeted costs that are not relevant to the decision regarding closing the plant and an explanation of why they are not relevant (again show the dollar amounts).

c) Any non-recurring costs that would arise due to the closing of the plant and an explanation of how they would affect the decision (again show any dollar amounts).

3. Looking at the data you prepared in (2) above, should the plant be closed? Show computations and explain your answer.

4. Identify any revenues or costs not specifically mentioned in the problem that AI should consider before making a decision.

d

$16000,000 Labour Direct Supervision Indirect plant $13400,000 800,000 3,800000 18,000000 Overhead Pension Plant manager and staff* Corporate expenses' 2600,000 4200,000 3,200,000 1200000 3400,000 14600,000 expense Total budgeted costs. "Expense for Rice and his regional staff Fixed corporate expenses allocated to plants and other operating units based on total budgeted wage and salary costs

Explanation / Answer

Solution- 1: Advantages of AI to continue manufacture the covers in its Own Woodstock cover plant:

Solution- 2a:

Working Note:

Solution- 2b:

Working Note:

- Pension Expense of only 1.4 Million is irrelevant since it will continue to be incurred whether plant is shut or now.

- Depreciation will continuously be charged whether the asset is being used or not.

- Plant Manager and Staff salary are unavoidable expense for this plant hence irrelevant.

Solution- 2c:

Working Note:

- Additional 1.6 mn will be spend on administering the training of laid-off employees.

- Salvage value of $ 4 million will be realized which will bring the net cost as -2.4 million.

Solution-3:

Analyzing 2a , we get the total relevant cost as 35.8 million while the offer came to the company at $42. Hence it is not advisable to shut the plant

Annual Budgeted cost relevant to shut down Item Amount Material 16,000,000 Labour: Direct 13,400,000 Supervision 800,000 Indirect Plant 3,800,000 Pension Expense 1,800,000 Total 35,800,000

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