Nearly $40 billion of sofas and sofa sets are sold each year in the United States^[1]. Making a sofa is a complex multi-step process. Making one by hand can take between 200-to-300 hours; however, a modern factory can make a sofa every 10-to-15 minutes. These reduced times are the result of automation and optimized factory layout and line balancing. Below are basic diagrams of how sofas are constructed.

According to Koruca, Koker, Chehbi-Gamoura and Ulsik (2018)^[2] in a modern well-run factory dedicated to manufacturing sofas, there are 32 workstations with an average cycle (Takt) time of 601.3 seconds. Assume that each workstation has one worker. The average American factory worker makes $15.00^[3] per hour, including fringes, benefits and payroll taxes total hourly cost is $20.10 per hour. In China the average factory workers salary is 8,000 Yuan per month^[4], which comes to $1,200 per month, or an hourly rate of $6.92. Including 20% for employers social security contribution (health insurance, maternity insurance, work related injury insurance and unemployment insurance) the hourly cost of a Chinese factory worker is $8.31 per hour. The average cost to ship a container from China to the Port of Los Angles is given in the table below^[5]. Depending upon the size of the sofa, there are anywhere from 8-to-18 sofas per shipping container.

A typical US furniture manufacturer sells 11,560 sofas annually. It spends $175 on raw materials per sofa and sells sofas to furniture stores at an average wholesale price of $650. This company is considering outsourcing the sofas to a Chinese manufacturer. If the company decides to outsource, it will purchase the sofas at an average price of $289 FOB. Approximately 3% of the sofas manufactured in the USA are damaged in transit while, 4% of the sofas made in China are damaged in transit. 98% of customers backorder a damaged sofa. The rehandling fees for damaged sofas are $250 each. It would be able to sell its production equipment for $1.2 million and get rid of its factory for $1.6 million; as well as the overhead and expenses associate with the factory.

Outsourcing eliminates direct labor cost. Outsourcing will also add $27,500 of other income as the result of investing some of the money from the sale of plant equipment and real estate; however, the bulk of the funds ($2,193,000) would go to stock (equity) buy-back; as well as, decreasing indirect labor and other operating cost by $1,805,000 and $748,500 respectfully. However, outsourcing increases cost of goods sold from $2,023,000 to $3,347,000; along with increasing transportation cost by $3,118,000. Concerning the balance sheet, outsourcing Increases current Liabilities by $871,000, decreases long term liabilities by $400,000, increases inventory by $528,000this is mainly due to transit and more safety stock, increases cash by $550,000, and decreases fixed assets by $2,800,000. The interest rate is 5%, the tax rate is 33%, and the inventory carrying rate is 25%.

From the information above, determine (1) the labor cost to build a sofa in each USA and China; (2) the labor cost difference between building a sofa in the USA and China; and, (3) using an average of 12 sofas per shipping container, calculate the average cost of shipping a sofa. (4) Assuming all other cost are equal, determine if the lower labor costs outweigh the shipping cost. (5) Construct an income statement and balance sheet for outsourcing to China, and (6) calculate all necessary financial ratios to assess whether the firm should keep manufacturing in the USA or outsource to China.

High $480 300 Standard Container Shipping Cost from China to USA Charge Low Factory to port $50 Clearance 100 Shipping Shenzhen, China to LA, CA. USA 2,230 Insurance (0.2%) 8 Port charges 100 Customs bond 100 Local Charges 100 2,460 18 450 200 450 Income Statement of Manufacturing in the USA Sales $9,800,000 Cost of goods sold $2,023,000 Gross Margin $7,777,000 Transportation $550,000 Warehousing $225,000 inventory carrying cost $57,000 Direct Labor $1,709,000 Indirect Labor $2,835,000 Other operating cost $1,036,000 Total Operating Cost $6,412,000 EBIT $1,365,000 Interest $43,950 Taxes $435,947 Net income $885,104 Liabilities Current liabilities Balance Sheet Assets Cash Account receivables Inventory $50,000 $279,000 $817,000 $228,000 Long-term debt Total liabilities $600,000 $879,000 $1,095,000 Total current assets Net fixed assets $3,050,000 Liabilities & Equity Stockholder equity Total liabilities & equity $3,266,000 Total assets $4,145,000 $4,145,000 High $480 300 Standard Container Shipping Cost from China to USA Charge Low Factory to port $50 Clearance 100 Shipping Shenzhen, China to LA, CA. USA 2,230 Insurance (0.2%) 8 Port charges 100 Customs bond 100 Local Charges 100 2,460 18 450 200 450 Income Statement of Manufacturing in the USA Sales $9,800,000 Cost of goods sold $2,023,000 Gross Margin $7,777,000 Transportation $550,000 Warehousing $225,000 inventory carrying cost $57,000 Direct Labor $1,709,000 Indirect Labor $2,835,000 Other operating cost $1,036,000 Total Operating Cost $6,412,000 EBIT $1,365,000 Interest $43,950 Taxes $435,947 Net income $885,104 Liabilities Current liabilities Balance Sheet Assets Cash Account receivables Inventory $50,000 $279,000 $817,000 $228,000 Long-term debt Total liabilities $600,000 $879,000 $1,095,000 Total current assets Net fixed assets $3,050,000 Liabilities & Equity Stockholder equity Total liabilities & equity $3,266,000 Total assets $4,145,000 $4,145,000