70.2K

Verified Solution

Link Copied!

CASE REQUIREMENT: Add learning points to this case. Indicate the pros and cons for each 3 Alternative courses of action and explain it briefly.

Fibertec is a Belgium-based company that manufactured and processed variety of natural products and used highly advanced material processing technologies.

Fibertec has a branch in Spain from the beginning. It has six (6) products departments that operates as a profit center supplying products globally. Fibertecs big clients are from industrial companies whose main business are special storage containers and household and industrial textile products, among many others.

Fibertec in Spain is being managed by Mr. Jorge Ruiz, the CEO of the Company. He is ably assisted by well-experienced officers who have been with the company for over 20 years.

The PTC Product Department manufactured one of the companys leading products: PTC. However, due to strong market competition, PTC failed to generate good margin.

The company received an offer from Engineering Tools to manufacture and adopt the 4,000 units of PTC for 975,000 per year that is to be increased proportionately with the level of demand.

The CEO then called the company accountant to provide him with the breakdown cost of the PTC Product Department to know the cost of producing PTC and compare it with the offer from Engineering Tools. How then, will the CEO decide in this make or buy decision is the object of analysis of this paper.

Statement of the Problem

Will the company outsource PTC from Engineering Tools to minimize manufacturing cost?

Statement of Objectives

Using the facts of the case, the analysis aims to further understand the following objectives:

To determine the relevant costs that can help Fibertech arrive at the best decision

To identify the advantages and disadvantages of make or buy options

Point of View

The case analysis will take the point of view of Mr. Jorge Ruiz, CEO of Fibertec.

Areas of Consideration/Analysis of Facts

Constraints for Decision Making

Complexity of Fibertech products necessitates collaboration among engineering teams

Employees skill in manufacturing of PTC and their skilled services to other departments

The quality of PTC being offered by Engineering Tools

Inventory of LT4 materials for four years

Acquisition and upgrading cost of machineries

Future of the employees under the PTC Product Department, most of them are with the company over 20 years.

Relevant Costs for Decision Making

David Barrios, head of the accounting department produce a breakdown of the cost of the PTC Product Department as follows:

Exhibit 1

PTC Product Department Cost

Particulars	Amount	Cost Relevance	Remarks
	(in EUR)
Product Materials	180,000		Direct Cost
Labor	600,000		Direct Cost
Salary of Martin Flores	60,000		Direct Cost
Rent	30,000		Period Cost
Annual Equipment Depreciation	75,000		Direct Cost
Equipment Maintenance	25,000		Direct Cost
Direct Departmental Expense	60,000		Direct Cost
Distributed Fibertech Overhead	50,000		Period Cost
Total Cost	1,080,000

David Barrios added that the IT Department can use the space occupied by PTC Product Department and save the 120,000 yearly rent. However, this is an issue separate from the present concern whether to produce or outsource the PTC product.

On the other hand, Martin Flores pointed out that outsourcing the production of PTC entails various costs of the termination of internal production such as:

LT4 Inventory loss

Gain/Loss on sale of On-hand LT4
1. Worth of LT4 used in first year (equivalent to 1/3 of total PTC Material Cost)
PTC Material per P&L	180,000.00
Multiplied by	1/3
Cost of LT4 used in Year 1	60,000.00
2. LT4 in Ending Inventory & no. of Tons
		Cost per Ton	# of Tons
Purchase Price	300,000.00	120	2,500
used during first year (1/5)	60,000.00	120	500
Ending Inventory - LT4	240,000.00		2,000
3. Gain/Loss on sale of On-Hand LT4
Cost per Ton	120.00
SP if Sold Now	100.00
Loss from Sale of LT4 per Ton	20.00
Ending Inventory	2,000
Loss from Sale of LT4 per Ton	40,000.00

Machinery Write off

Gain/Loss on sale of Equipment	EUR
Machine Purchase Cost	600,000.00
Accumulated Depn
(600k/8yrs*4yrs)	(300,000.00)
Net Book Value	300,000.00
Selling Price if Sold now	(100,000.00)
Loss on Sale of Machine	200,000.00

Severance pay of terminated employees = 660,000

Other Constraints

Particulars	Amount	Cost Relevance	Remarks
	(in EUR)
LT4 loss	40,000		Direct Material Cost
Loss on Sale of Machine	200,000		Period Cost
Severance Pay	660,000		Direct Labor Cost
IT Dept building rent	120,000		Opportunity Cost

Table of Comparison between Make and Buy Costs

	Cost to Make	Cost to buy
Offer Price		975,000.00
Product Materials	180,000.00
Labor	600,000.00
Annual Depreciation	75,000.00
Equipment Maintenance	25,000.00
Direct Departmental Expense	60,000.00
IT building Rent	120,000.00
LT4 Inventory loss		40,000.00
Loss on Sale of Equipment		200,000.00
Severance Pay		660,000.00
Total Yearly Cost for 5 yrs	1,060,000.00	1,875,000.00
Savings to Keep/Make		815,000.00

Schedule of the Yearly Comparison

	Year 1	Year 2	Year 3	Year 4	Year 5	Years 1 to 5
Make	1,060,000.00	1,060,000.00	1,060,000.00	1,060,000.00	1,060,000.00	5,300,000.00
Buy	1,875,000.00	975,000.00	975,000.00	975,000.00	975,000.00	5,775,000.00
Difference	(815,000.00)	85,000.00	85,000.00	85,000.00	85,000.00	(475,000.00)

Alternative Courses of Actions

ACA 1: Accept the five years contract from Engineering Tools to manufacture the PTC.

PROS:

Increase in profit margin of the company

Eliminate manufacturing cost of PTC

High cost margin ratio

Factory Space of PTC used by IT Dept will translate into annual rent savings of 120,000

CONS:

Dissolve the PTC Product Department of Fibertec

Pay the separation pay amounting to EUR660,000 if the management will terminate the contracts of employees under the PTC Product Department

Low quality of PTC product

B. ACA 2: Retain the PTC Product Department and continuously manufacture the PTC

PROS:

High quality of PTC products

Availability of LT4 materials for five years

The cost of LT4 materials will be fixed for five years

Maintains customers preference on PTC

CONS:

Low profit margin

High overhead cost (??)

C. ACA 3: Fibertec will only outsource PTC from Engineering Tools if theres a bulk of orders from their big clients/customers and if PTC Product Department will not able to produce the needed units of PTC to meet the target date of delivery.

PROS:

Higher profit margin

Minimize manufacturing cost

Increase sales or revenues

Conclusion and Implementation

Being the CEO, after looking at the cost analysis of the make or buy decision and their respective advantages and disadvantages, we will adopt ACA 2 and ACA 3, that is, manufacture the PTC and in the event of temporary excess demand opt to outsource the production.

Cost saving strategy is the most common method of assuring the bottom line in many companies at the expense of losing jobs. Jobs can be retained as well as the bottom line assured when there is transparency and accountability in the decision making.

Answer & Explanation Solved by verified expert

See Answer