Falco Services processes mortgage loan applications. The cost of home appraisals is included in its service fee, but Falco uses an outside appraisal service. The cost of appraisals has been increasing rapidly over the last several years, reaching $180 per appraisal last year. Falco’s CFO asked one of the accountants to estimate the cost of doing the appraisals in-house. Several of Falco’s mortgage brokers worked previously as real estate agents and have performed informal appraisals; however, none have professional appraisal experience. The accountant’s son-in-law owns the firm that currently performs most of the appraisals.

The accountant prepares a report for the CFO that includes the following estimates for 1,000 appraisals. Appraisers would have to be hired, but no additional computer equipment, space, or supervision would be needed. The report states that the total costs for 1,000 appraisals would be $195,000 or $195 per appraisal. The current appraisal price is $180, so the report recommends that Falco continue to outsource the appraisal services.

Costs:

Supplies and paper ....     $   5,000

Professional labor .......     100,000

Overhead .....................        90,000

Total costs ...................    $195,000

Cost per appraisal ......    $       195

Professional labor is the cost to hire two appraisers. Overhead consists of fixed overhead, which is allocated at 50% of the cost of professional labor, and variable overhead (mostly fringe benefits), which is 40% of the cost of professional labor. Falco’s CFO has to decide whether to continue to use the appraisal service or to hire appraisers and provide the service in-house.

REQUIRED

A. Which type of non-routine operating decision is involved here? What are the managers’ decision options?

B. What is the expected total incremental cost for 1,000 appraisals?

C. Which costs in the accountant’s report are not relevant? Prepare a revised report that includes only relevant costs.

D. Using the general decision rule, should Falco outsource appraisal services or provide this service itself?

E. List risk factors about Falco’s ability to begin a new appraisal service at or below the cost calculated. List as many risks as you can.

F. List additional qualitative factors that Falco’s CFO should consider in making this decision.

List as many as you can.

G. Explain why the accountant might have been biased, and explain what effects that might have on the cost report.

H. What are the costs to Falco of relying on the accountant’s report for this decision? What are the costs to the accountant of admitting that he might be biased in preparing information for this decision?