McGinn Chemical Company, located in Monroe, Louisiana, has one product, a liquid chemical, which it is selling to paper mills for use in producing paper. McGinn Chemical Companys total sales are $2,000,000 per year. McGinn Chemical has been manufacturing the product for 10 years, but it is considering letting Herrington Industries, a large manufacturing company, make it for them. If they let Herrington manufacturer the product, McGinn would buy it from Herrington and then resell the product to the paper mills. McGinn can buy the product from Herrington for $5.00 per gallon or make the product for $4.30 per gallon. These cost figures include only the costs of raw materials and freight. The product is sold for $7.00 per gallon to the paper mills. Should the company make or buy? You should show one yearly income statement for making and one yearly income statement for buying. You should state the reasons (financial and other reasons) for your decision.

Additional Information

McGinn's present equipment needs replacing immediately if the company continues to manufacture the product. McGinn has enough cash on hand to pay for the equipment.

Investment in equipment: $100,000

The equipment has a 10 year life ($10,000/yr. in depreciation). Number of Employees: 9

Who are the employees:

2 office workers

3 warehouse people

3 salespeople

1 president/owner

Salaries at present:

Office workers: $25,000 per year each

Warehouse people: $25,000 per year each

Salespeople: commission 40% of gross profit per gallon that each sells

President/owner: $90,000 (This is an annual salary. The president is not on commission. He is involved in all parts of the business.)

Salespeoples' sales:

A: $500,000

B: $250,000

C: $250,000

President's sales: $1,000,000

Past Sales: $2 million per year in each of the last 3 years.

Age of company: McGinn is 10 years old.

Product liability insurance: $10,000/yr. if buy or $65,000 if make

Rent: $1,500/month (buy)

$3,000/month (make)

Office Supplies: 4,000/year (either way)

Warehouse Supplies: $2,000/yr. if buy, $7,000/yr. if make

Percent of their time that employees spend on making product (if McGinn makes the

product):

Each of warehouse people will spend 40% of his/her time making the product. President (who is a chemist) will spend 20% of his time.

One of office workers will spend 20% of his/her time.

Repairs and maintenance on the manufacturing equipment (if make): $15,000/yr.

Ingredients: 14 different raw materials are purchased from 12 different companies Experience of employees:

One salesperson has been at McGinn for three years, and

two office workers have been there for three years. President has been there ten years. Everyone else has been there for one year.

Safety equipment and disposal services needed (if make): $30,000

Utilities: $500/mo. if buy

$1,000/mo. if make

All other expenses: $30,000/yr. (either way)

The president believes the main competitive strength of McGinn is the selling abilities of the employees.

The company that would make the product (Herrington) has an excellent reputation for high ethical standards. McGinn once had an employee that stole its formula book.

McGinn has 10% of the market. There is no dominant player in the market.

The president has promised the salespeople that if McGinn decides to buy instead of make, it will pay 50% of the gross profit per gallon as a commission.