Factory Closing Decision

The Dough Knot Corporation bakes breads, pastries, cookies and every other baked good imaginable. The company has a number of factories around the world, including the ELAC Cookie Factory, which makes... cookies.

Michael Schrute is the factory manager of the ELAC Cookie Factory but also serves as the regional production manager for the company. His budget as the regional manager is charged to the ELAC Cookie Factory.

Schrute has just heard that The Dough Knot has received a bid from an outside vendor to supply the equivalent of the entire annual output of the ELAC Cookie Factory for $34 million. Schrute was astonished at the low outside bid because the budget for the ELAC Cookie Factorys operating costs for the upcoming year was set at $50.3 million. If this bid is accepted, the ELAC Cookie Factory will be closed down.

The budget for ELAC Covers operating costs for the coming year is presented below.

ELAC Cookie Factory Annual Budget for Operating Costs

Baking flour	$2,500,000
Baking Employees	$12,000,000
Butter	$3,700,000
Chocolate	$2,400,000
Cleaning Employees	$1,500,000
Corporate Expenses	$3,800,000
Depreciation-Building	$6,000,000
Depreciation-Equipment	$3,500,000
Pension Expense	$4,000,000
Factory manager and staff	$900,000
Security employees	$3,000,000
Sugar	$6,000,000
Supervisors	$1,000,000
Total Budgeted Costs	$50,300,000

*Fixed corporate expenses allocated to factories and other operating units based on total budgeted wage and salary costs.

Additional facts regarding the factorys operations are as follows:

a.) Due to ELAC Cookies commitment to use high-quality ingredients in all of its products, the Purchasing Department was instructed to place blanket purchase orders with major suppliers to ensure the receipt of sufficient materials for the coming year. If these orders are canceled as a consequence of the factory closing, termination charges would amount to 25% of the cost of direct materials.

b.) Approximately 400 factory employees will lose their jobs if the factory is closed. This includes all of the direct laborers and supervisors as well as the plumbers, electricians, and other skilled workers classified as indirect factory workers. Some would be able to find new jobs while many others would have difficulty. All employees would have difficulty matching ELAC Cookies base pay of $18.80 per hour, which is the highest in the area. A clause in ELAC Cookies contract with the union may help some employees; the company must provide employment assistance to its former employees for 12 months after a factory closing. The estimated cost to administer this service would be $1.6 million for the year.

c.) Some employees would probably choose early retirement because The Dough Knot has an excellent pension plan. In fact, $2.5 million of the annual pension expense would continue whether ELAC Cookie is open or not.

d.) Schrute and his staff would not be affected by the closing of ELAC Cover. They would still be responsible for administering three other area factories.

e.) If the ELAC Cookie Factory were closed, the company would realize about $3.3 million salvage value for the equipment and building. If the factory remains open, there are no plans to make any significant investments in new equipment or buildings. The old equipment is adequate and should last indefinitely.

Required:

The Dough Knot Corporation plans to prepare a financial analysis that will be used in deciding whether or not to close the ELAC Cookie Factory. Management has asked you to identify:

4.) Any nonrecurring costs that would arise due to the closing of the factory. Looking at the data you have prepared above,

5.) Calculate the financial advantage (disadvantage) of closing the factory.

6.) Should the factory be closed? Explain your calculations and support your argument. Its your job to convince the CEO of your decision (500 words minimum).

(Part of your score will be based on your ability to argue your strategy. You may come to the correct numerical calculation, but if you cannot convey your message your recommendation will fall flat with the CEO. For questions 2 & 3, you should show your calculations and support your argument, as if you were making a presentation to management.)