Sergo Games-
Sergo Games produced action video games, one kf which sold more than 700,000 copies last year. athe games need a special USB controller and the company operates its own production facility that manufactures and packages the controllers for shipment to customers. In 2018, they lroduced 2,000,000 controllers and incurred the following costs:
Untis Produced- 2,000,000
Labor- $600,000
Materials- 4,000,000
Supervisors' salaries- 200,000
Equipment depreciation- 300,000
Utilities- 100,000
Total- $5,200,000
William Stowers, controller, has been given the responsibility to analyze outsourcing the production. His report is provided below:
Sergo Games produced action video games, one of which sold more than 700,000 copies last year. The games need a special USB controller and the company operates its own production facility that manufactures and packages the controllers for shipment to customers. In 2018, they produced 2,000,000 controllers and incurred the following costs: Units produced 2,000,000 Labor $600,000 Materials 4,000,000 Supervisors' salaries 200,000 Equipment depreciation 300,000 Utilities 100.000 Total $5,200,000 William Stowers, controller, has been given the responsibility to analyze outsourcing the production. His report is provided below: December 9, 2019 To: Georgia McManus, CFO From: William Stowers Subject: Outsourcing Controller Production In 2018, total production costs were $5,200,000 or $2.60 per controller. The low-cost outside bidder for the production was Altergo, inc. They are a highly respected company and their offer is $2.50 per controller. Although the savings related to outsourcing is only $0.10 per unit, with annual production of 2 million units, this amounts to $200,000 per year. The present value of the savings, with a five-year horizon and a a10% cost of capital is $758,157. Thus I recommend that we outsource the controller production. You also asked me to determine the selling price of our existing production equipment. I showed it to Altergo's representative. He said the equipment ids dated and the market value is essentially zero. At any rate, they are not interested in purchasing the equipment even if we select them as a supplier. If we outsource, we cannot use the facility for another purpose. As you know, the building is run down and it's not even a suitable space for programmers! Finally, I want to mention another issue that enhances the appeal of outsourcing. The equipment is currently on our books at $1,500,000 with an expected remaining life of 5 years. This generates $300,000 per year of depreciation expense. If we outsource, we'll have a $1.500,000 tax loss on disposal of the equipment, which will save us approximately $525,000, assuming a 35% tax rate. Thus the total value of outsourcing is $758,157 + $525,000 = $1,283,157. Please call me if you have any questions regarding this analysis. In 2018, they produced 2,000,000 controllers and incurred the following costs: Units produced 2,000,000 Labor $600,000 Materials 4,000,000 Supervisors' salaries 200,000 Equipment depreciation 300,000 Utilities 100,000 Total $5,200,000 William Stowers, controller, has been given the responsibility to analyze outsourcing the production. His report is provided below: December 9, 2019 To: Georgia McManus, CFO From: William Stowers Subject: Outsourcing Controller Production In 2018, total production costs were $5,200,000 or $2.60 per controller. The low-cost outside bidder for the production was Altergo, inc. They are a highly respected company and their offer is $2.50 per controller. Although the savings related to outsourcing is only $0.10 per unit with annual production of 2 million units, this amounts to $200,000 per year. The present value of the savings, with a five-year horizon and a 10% cost of capital is $758,157. Thus I recommend that we outsource the controller production. You also asked me to determine the selling price of our existing production equipment. I showed it to Altergo's representative. He said the equipment ids dated and the market value is essentially zero. At any rate, they are not interested in purchasing the equipment even if we select them as a supplier. If we outsource, we cannot use the facility for another purpose. As you know, the building is run down and it's not even a suitable space for programmers! Finally, I want to mention another issue that enhances the appeal of outsourcing. The equipment is currently on our books at $1,500,000 with an expected remaining life of 5 years. This generates $300,000 per year of depreciation expense. If we outsource, we'll have a $1.500,000 tax loss on disposal of the equipment, which will save us approximately $525,000, assuming a 35% tax rate. Thus the total value of outsourcing is $758,157 + $525,000 = $1,283,157. Please call me if you have any questions regarding this analysis
