Amao, Manufacturing was founded in a small northeastern city more than a century ago. The founder started the firm alongside a fast-moving stream that provided mechanical power to drive cutting tools, grinders, lathes, and polishers. These tools were used to produce precision parts other manufacturers needed. The company has a proposal to stop manufacturing one product, the Socket Weld SW40, and instead acquire it from an overseas supplier. This product currently represents 30% of the total sales revenue and production volume. But sales have been declining because competitors are offering a similar product at lower prices. They think that by reducing the price by 5% they can increase unit sales volume by 15%. The increased volume coupled with a lower product cost from the offshore supplier should nearly double the firm-wide profit. Sales of the Socket Weld SW40 were $27 million last year (Year 5). The direct material costs came to $14.3 million, while overhead costs of $4.2 million were allocated to the product. But only $2.9 million of the overhead will be avoided if they stop manufacturing the Socket Weld SW40. The remaining overhead costs are nearly all fixed and not subject to reduction in the near future. The direct selling costs consist mostly of an 8% commission paid to sales representatives. In addition, there's a $2 million advertising allowance devoted to promoting the Socket Weld SW40 in trade magazines. By outsourcing the Socket Weld SW 40, they can release three administrative managers, eight administrative support staff, 128 general production personnel, and 10 supervisors. The supplier's cost quotation (Exhibit 1) needs to be adjusted for the expected 15% increase in volume. The cost for materials and labor will increase proportionately, but the overhead and 'other' costs are unlikely to be affected. The supplier's mark-up will be 10% of the new total cost. In addition to the product cost, Amao will incur transportation costs to get the product from the manufacturer to our warehouse. The transportation costs are variable and would have been $0.6 million for the volume of product in Year 5. Exhibit 1: Off-Shore Supplier's Price Proposal for the Volume of Socket Weld SW40 in Year 5 Material Costs $12.7 Labor Costs 1.8 Overhead Costs 2.7 Other 1.5 Total 18.7 Profit Mark-Up (10%) Total Price 1.9 20.6 Exhibit 2: Distribution of Current Patterson Employees by Job Title Job Title Number of Employees Administrative Manager 10 Administrative Staff 24 Production Supervisor 29 General Production Personnel 417 Average Salary Per Employee $45,000 32.000 50,000 37,000 1. Prepare an analysis of the expected effect of outsourcing the product on Amao's profitability. 2. Would it be a viable alternative to produce the product locally and lower the price to achieve the increase in sales volume? Amao, Manufacturing was founded in a small northeastern city more than a century ago. The founder started the firm alongside a fast-moving stream that provided mechanical power to drive cutting tools, grinders, lathes, and polishers. These tools were used to produce precision parts other manufacturers needed. The company has a proposal to stop manufacturing one product, the Socket Weld SW40, and instead acquire it from an overseas supplier. This product currently represents 30% of the total sales revenue and production volume. But sales have been declining because competitors are offering a similar product at lower prices. They think that by reducing the price by 5% they can increase unit sales volume by 15%. The increased volume coupled with a lower product cost from the offshore supplier should nearly double the firm-wide profit. Sales of the Socket Weld SW40 were $27 million last year (Year 5). The direct material costs came to $14.3 million, while overhead costs of $4.2 million were allocated to the product. But only $2.9 million of the overhead will be avoided if they stop manufacturing the Socket Weld SW40. The remaining overhead costs are nearly all fixed and not subject to reduction in the near future. The direct selling costs consist mostly of an 8% commission paid to sales representatives. In addition, there's a $2 million advertising allowance devoted to promoting the Socket Weld SW40 in trade magazines. By outsourcing the Socket Weld SW 40, they can release three administrative managers, eight administrative support staff, 128 general production personnel, and 10 supervisors. The supplier's cost quotation (Exhibit 1) needs to be adjusted for the expected 15% increase in volume. The cost for materials and labor will increase proportionately, but the overhead and 'other' costs are unlikely to be affected. The supplier's mark-up will be 10% of the new total cost. In addition to the product cost, Amao will incur transportation costs to get the product from the manufacturer to our warehouse. The transportation costs are variable and would have been $0.6 million for the volume of product in Year 5. Exhibit 1: Off-Shore Supplier's Price Proposal for the Volume of Socket Weld SW40 in Year 5 Material Costs $12.7 Labor Costs 1.8 Overhead Costs 2.7 Other 1.5 Total 18.7 Profit Mark-Up (10%) Total Price 1.9 20.6 Exhibit 2: Distribution of Current Patterson Employees by Job Title Job Title Number of Employees Administrative Manager 10 Administrative Staff 24 Production Supervisor 29 General Production Personnel 417 Average Salary Per Employee $45,000 32.000 50,000 37,000 1. Prepare an analysis of the expected effect of outsourcing the product on Amao's profitability. 2. Would it be a viable alternative to produce the product locally and lower the price to achieve the increase in sales volume