Liquid Chemical Company: 1. Background Analysis

Liquid Chemical Company
1. Background Analysis
-Liquid chemical company manufactured and sold a range of high-grade products in Great
Britain, with special packing, included patented lining, made from a material known as GHL.
-Dale Walsh(the GM) thought of getting money saved and good service by buying containers
outsource and asked for Packages Ltd; a supplier for a quotation and an up-to-date statement
on the operation cost of the container dept.from Paul Dyer (the Chief Accountant)
-Quotation from Packages Ltd:
Agreed to supply required new containers
At the rate of 3,000 a year (£300,000/year)
Guaranteed contract of 5 years and to be renewable from year to year
Contract price would be increased proportionally if the number of containers rose

Carry out maintenance work on containers for £90,000/year on the same contract term,
irrespective whether the contract was entered into/not
The container's dept.year's operation prepared by Dyer:
£ £
Materials 178,360
Labour 126,000
Department overhead
Manager's salary 20,300
Rent 11,480
Depreciation of machinery 38,220
Maintenance of machinery 9,170
Other expenses 40,120
119,290
423,650
Proportion of general administrative overhead 57,330
Total cost of Dept. for a year 480,980
- Walsh discussed with Sean Duffy, the Container Dept.Manager to give him opportunity for
questions before the act taken
- Duffy's main considerations:
Machinery cost: £300,000 4 years ago (Selling price: £50,000), it is good for 4 years or so
GHL stock: £255,000 (bought a year ago), it will last for 4 years or so. Used up about 1/5 last
year
Materials: £178,360, probably includes GHL (£51,000)
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Bought at price of (£1,275/ton, today's selling price: £1,450), last selling price: £1,100/ton)
Dyer's point: Rent cost: £21,840/year hence would save that amount if the container dept.were
to be closed
Walsh concern: pensions for the company's 2 long term workers: £4,000/year for each person
Existing expense: General administrative overhead of £57,330
Possible saving if the maintenance were to be done internally:

-Machinery is no longer needed under a foreman supervision (Saving of £5,500 a year)
-only 1/3 workers needed (the oldest can be kept)
-No saving for the space internally and at the rented warehouse
-The other materials: would not be more than £16,500/year
-Other materials: 10% on container maintenance
2. Identify problem
-The need for operation efficiency in order to save company's money and time and at the same
time to increase profit
-The decision need to be made on how the running of the company's container operation: in
house or outside source (Packages Ltd.)
3. Identify alternatives implied in the case
- Alternative 1: in house operation, to keep the container dept.taking care of the containers
supply and other related matters
- Alternative 2: outside source by a supplier (Packages Ltd) on the container supply,
maintenance and other related matters
4. The Analysis (Answers solution)
4. Calculate the cash flow implications of each alternative. Which Alternative is the most
attractive?
The computation as follows:
Alternative I : in house operation
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Cash flow implication for in house operation:
Year 1 Year 2 Year 3 Year 4 Year 5 Total

GHL 51,000 51,000 51,000 51,000 58,000 262,000
Other material 127,360 127,360 127,360 127,360 127,360 636,800
Labor 126,000 126,000 126,000 126,000 126,000 630,000
Manager's salary 20,300 20,300 20,300 20,300 20,300 101,500
Rent 21,840 21,840 21,840 21,840 21,840 109,200
Maintenance of machinery 9,170 9,170 9,170 9,170 9,170 45,850
Other expenses 40,120 40,120 40,120 40,120 40,120 200,600
Total 395,790 395,790 395,790 395,790 402,790 1,985,950
Adjustment to Cash Flow

GHL (51,000) (51,000) (51,000) (51,000) (204,000)
Total adjustment to Cash Flow (51,000) (51,000) (51,000) (51,000) 0 (204,000)
Total 344,790 344,790 344,790 344,790 402,790 1,781,950
Alternative 2 - outsource source

Cash flow implication for outside source (Packages Ltd):

Disposal of GHL
Revenue (176,000) (176,000)
Cost 204,000 204,000
Disposal of machine
Revenue (50,000) (50,000)
Pension 8,000 8,000 8,000 8,000 8,000 40,000
Cost of containers replaced 300,000 300,000 300,000 300,000 300,000 1,500,000
Cost of maintenance of containers 90,000 90,000 90,000 90,000 90,000 450,000
Total 376,000 398,000 398,000 398,000 398,000 1,968,000
Adjustment to Cash Flow

GHL (204,000) (204,000)
Total adjustment to Cash Flow (204,000) (204,000)
Total 172,000 398,000 398,000 398,000 398,000 1,764,000
Difference 17,950
The most attractive alternative is to use the outside source as the saving for 5 years is £17,950
In terms of container maintenance:
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Per Year ( £ )
Cash flow implication in house maintenance:
Labor 42,000
Manager's salary 14,800
Materials 17,836
Other expenses 16,500
Total cost 91,136
Cash flow implication of outside source maintenance (Packages, Ltd) :
Cost of maintenance of containers 90,000

Pension 8,000
Total cost 98,000
Difference (6,864)
As shown by the computation of maintenance of the container, the saving for in house
maintenance is £6,864 per year
5. Additional Information
Additional important information is hurdle rate to calculate the PV in 5 years, the depreciation
method and the tax rate.
6. Recommendation
Dear Mr. Walsh,

In regards to your decision to keep the in house operation or outside source to packages Ltd.,
the computation above shown that there is 17,950 saving in 5 years if you do outside source to
Packages Ltd. However the moral responsibility of employees lay off's possibility in comparison
to that small amount that your company might save, I am suggesting that the in house operation
is to be kept.
From the containers maintenance's point of view, the in house is suggested as there will be
£56,864 saving per year.
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Liquid Chemical Company

Contract price would be increased proportionally if the number of containers rose

The container's dept.year's operation prepared by Dyer:

Possible saving if the maintenance were to be done internally:

3. Identify alternatives implied in the case

4. The Analysis (Answers solution)

The computation as follows:

Alternative I : in house operation

Year 1 Year 2 Year 3 Year 4 Year 5 Total

Adjustment to Cash Flow

Year 1 Year 2 Year 3 Year 4 Year 5 Total

Alternative 2 - outsource source

Year 1 Year 2 Year 3 Year 4 Year 5 Total

Adjustment to Cash Flow

Year 1 Year 2 Year 3 Year 4 Year 5 Total

In terms of container maintenance:

Cash flow implication of outside source maintenance (Packages, Ltd) :

Cost of maintenance of containers 90,000

Dear Mr. Walsh,

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