# Cases in Cost Management

## Quiz 33 :Wellington Chemicals

Question Type
One common approach in analyzing a situation like this is to prepare a comprehensive, multi-year cash flows spreadsheet for the various options. This requires careful attention to differential cash flows, a relevant time frame, inflation, taxation, and time value of money. If you choose this approach, be careful in carrying it through comprehensively and in considering what inferences it will support. Assume a 40% tax rate. If you choose some other cost analysis approach, be sure you are clear as to why you are not doing a multiyear spreadsheet analysis. What conclusions do you draw from your cost analysis What recommendation would you make to Mr. Walsh Why
Free
Essay

Decision to Make Vs Buy for packaging containers :
Working Notes:
1. The exchange rate in 1965 was $2.80/£. 2. Approximate earning of a worker is approximate £3,000/year. • Pension amount comes out at £1,500 at about fifty percent of regular pay • Earnings of foreman is approximate £5,000 3. Hence, the workforce comes out to be 15 people 4. Consumption of GHL by Wellington is 40 tons per annum . 5. Consumption of GHL by Wellington for making new containers is 36 tons (90%). 6. Size of the containers : • The basic steel cost in the year 1965 was$360/ton in the U.S
• This is approximate 390 tons of steel
• Therefore, for 3000 new containers, it will come around 260 pounds per container
• Since a standard drum has weight around 30 pounds, therefore the size of each drum will be approximate 500 gallons.
7. Since the price offered by Packages Ltd. is £41.67
which is fixed for five years. Therefore, at 4% inflation it must be around £38 for the first year, with a five-year projection about 38, 40, 42, 44, 46.
8. Considering about 5 pounds/gallon, each drum has the capacity of holding approximate 1.25 tons of chemical.
9. Considering current GHL price of £600 per T for specialty chemicals, the selling price of one drum comes out to be approximate £750.
10. It is unclear how allocation of administrative overhead was made but the amount of £22,500 is fifty percent of hourly labor.
11. Estimates made by Duffy for "maintenance cost" at wellington:
12. Therefore, cost of each new drum comes out to be
which can be compared to "buy" cost of appx. £38 in the year 1965 (Refer working note 7).
13. As per the case, drums can be reused many times with proper maintenance. Since on an average drums can be used 12 times therefore the cost per usage comes out to be approximate £4.4, which is less than one percent of the value of the contents (estimated at £750).
A detailed Cash-flow analysis:
A more comprehensive analysis considering cash flows, taxes, inflation, tax shields and the time value of money over a four year period that means the remaining life of the equipment and GHL inventory is presented as below:
Conclusions:
Based on the above workings, following conclusion can be made:
1. Wellington should make everything on its own to maintain complete control.
2. Buying seems to be economically justified, therefore outsourcing is possible. (£189,350 versus £162,500).
3. On an incremental basis, making seems to be economically justified, therefore do not outsource. (£162,500 versus £147,350 [£189,350 less depreciation of £15,000 and less allocated costs of £4,500 and £22,500])

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