Review of Chapters 11 and 12. (D. Solomons, adapted) The Rainier Company sells a range of high-grade chemical products that calls for careful packaging. The company has always made a feature of the special properties of the containers used. They had a special patented lining made from a material known as GHJ, and the firm operated a department especially to maintain its containers in good condition and to make new ones to replace those past repair.

Ms. Wood, the general manager, had for some time suspected that the firm might save money and get equally good service by buying its containers outside. After careful inquiries, she approached a firm specializing in container production, Closure Inc., and obtained quotations from them. At the same time she asked Mr. Wrend, the‘controller, for an up-to-date statement of the cost of operating the container department.
Within a few days the quotation from Closure came in. They were prepared to supply all the new containers required—at that time running at the rate of 15,000 a year—for $300,000 per annum, the contract to run for a term of five years certain and thereafter to be renewable from year to year. If the number of containers required increased, the contract price would be increased proportionately. Additionally, irrespective of whether the above contract was concluded, Closure undertook to carry out purely maintenance work on containers, short of replacement, for a sum of $70,000 per annum on the same contract terms.
Ms. Wood compared these figures with the following cost figures prepared by Wrend covering a year’s operations of the container department:Materials $100,000 Direct labor 175,000 Departmental overhead:
Supervision $50,000 Rent 6,000 Depreciation of machinery 30,000 Maintenance of machinery 7,000 Other expenses 31,000 124,000 $399,000 Proportion of general administrative overhead 33,000 Total cost of department for year $432,000 Wood leaned toward eliminating the department and entering into the contracts offered by Closure. However, before proceeding, she asked for the observations of the manager of the department, Mr. Spencer; at the same time, she made it clear that Spencer’s own employment was not in jeopardy. Even if his department were abolished, there was another managerial position shortly becoming vacant to which Spencer could move without loss of pay or prospects.
Spencer raised a number of considerations. “For instance,” he said, “what will you do with the machinery? It cost $240,000 four years ago, but you’d be lucky if you got $40,000 for it now, even though it’s good for another five years at least. And then there’s the stock of GHJ we bought a year ago. That cost us $120,000 and at the rate we’re using it now, it will last us another three years or so. We used up a quarter of it last year. Wrend’s figure of $100,000 for materials probably includes about $30,000 for GHJ. But it will be tricky stuff to handle if we don’t use it up. We bought cheaply—$150 a ton we paid for it—and you couldn’t buy it today for less than $180. But you wouldn’t have more than $120 a ton left if you sold it, net of all handling expenses.” Wrend was present during this discussion. He said, “I don’t much like all this conjecture. My figures are pretty conclusive. Besides, if we are going to have all this talk about ‘what will happen if,’ don’t forget our problem of space. We’re paying $10,000 a year in rent for a warehouse two miles away.

If we closed Spencer’s department, we’d have all the warehouse space we need without renting.”
“That’s a good point,” said Wood. “Though we should not forget that the total termination costs for the oldest employees released will amount to $14,000 annually for five years.” Spencer said, “What about this $33,000 for general administrative overhead? You surely don’t expect to fire anyone in the general office if I’m closed down, do you?” “Probably not,” said Wrend, “but someone has to pay for these costs. We can’t ignore them when we look at an individual department. If we do that with each department in turn, we shall finish by convincing ourselves that general managers, accountants, typists, stationery and the like, don’t have to be paid for. And they do, believe me.”
“Well, I think we’ve thrashed this out pretty fully,” said Wood, “but I’ve been turning over in my mind the possibility of perhaps keeping on the main- tenance work ourselves. What are your views on that, Spencer?” “I don’t know,” said Spencer, “but it’s worth looking into. We won’t need any machinery for that, and the supervision could be handled by a foreman. You’d save $30,000 a year there, say. You’d only need about one-fifth of the workers, but you could retain the oldest. You wouldn’t save any space, so I suppose the rent would be the same. I don’t think the other expenses would be more than $13,000 a year.” “What about materials?” asked Wood. “We use about 10 percent of the total on maintenance,” Spencer replied. “That is, we use about $10,000 per year on maintenance—no GHJ is required.”
“Well, P’ve told Closure that I’d let them know my decision within a week,”
said Wood. “T’ll let you know what I decide to do before I write to them.”
. Assume that the time value of money is 20 percent. Ignore income taxes. What action should be taken? Show your analysis. Prepare a clear-cut quantitative analysis. Specify your assumptions.
. Describe any sensitivity analysis that seems particularly advisable. Without doing calculations, predict the effect of the sensitivity analysis on your final computations. For example, what would happen to your two best alternatives if the time value of money were 10 percent instead of 20 percent? State the possible influence of the nonquantified factors on the decision.
Note Problems 12-29 through 12-33 cover the accounting model, which is discussed in Appendix A of this chapter.  L01