Question

Company XYZ is considering outsourcing their Product A.

Facts:

1) Product A makes up 30% of a companies sales revenue and production volume
2) By reducing sales price 5%, can increase unit sales volume by 15%
3) Product A sales were $27 million last year
4) Direct material costs for Product A were $14.3 million and overhead costs were $4.2 million
5) If product is outsourced, only $2.9 million overhead will be avoided
6) Direct selling costs are 8% commission to sales reps, and $2 million advertising
7) Layoffs due to outsourcing will include 3 admin managers (saving $135,000), 8 admin support staff (saving $256,000), 10 supervisors (saving $500,000), and 128 production personnel (saving $4,736,000).
8) XYZ will incur one-time charge of $1 million for severance pay for dismissed employees
9) XYZ will need to spend $200,000 for construction of receiving facilities for outsourced product

CURRENT:

All Products
Sales 90.2
COGS 74.3
Gross Margin 15.9
Admin Costs 1.6
Selling Costs 11.2
Net Income 3.1

Product A Only
Sales 27
COGS 18.5
Gross Margin 8.5

IF PRODUCT A OUTSOURCED:
Material costs 14.6
Labor 2.1
Overhead 2.7
Other 1.5
20.9
Markup 10% 2.1
Transportation 0.6
Total Cost 23.6

QUESTIONS:

1) IF Company XYZ chooses to outsource Product A, what would be the expected Net Income for the company?
2) What would be the Gross profit margin for Product A?

Answer 1

(1) Computation of the expected net income for the company if company XYZ chooses to outsource product A.We have,

Particulars		Amount(Million $)
Sales	90.2 - 27.0 + ( 27 + 27*15% - 27*5%)	92.7
Less: COGS	74.3 - 18.5 + 1.3 + 23.6 + 1.2 - 4.7	77.2
Gross Margin		15.5
Less: Admin Cost	1.6 - 0.90	0.70
Less: Selling cost	11.2 - ( 27*8% + 2.0)	7.04
Expected Net Income		$ 7.76

(2) Computation of the gross profit margin for product A.We have,

Particulars	Amount in million ($)
Sales	29.5
Less: Cost of Good sold	23.6
Gross profit margin	$ 5.9