Question

RiverView College is considering outsourcing their janitorial services. They have received a bid from Sparkles, LLC for $800,000 per year. Sparkles states that its bid will cover all services and cleaning supplies and that the facilities will "sparkle" as brightly as they have in the past. RiverView's costs for janitorial services in the preceding year were $825,000 as follows:

Salary of full time janitorial employees				$ 520,000
Cleaning Supplies				272,000
Depreciation of cleaning equipment				33,000
Total				$ 825,000

If Riverview outsources the janitorial services they will be able to sell the cleaning equipment for $45,000 and the janitorial employees will be laid off.

a. What is the incremental profit or loss of outsourcing janitorial services in year 1?

b. How will savings in the second year differ from those in year 1?

c. What are some qualitative issues that should be considered?

Answer 1

a. Incremental cash flows for the first year = 825000-800000 + 45000 = 70000

b. Savings for second year = 825000-800000 = 25000

c. Qualitative issues that should be considered:

1. Tax benefits of depreciation of equipment

2. Laid off janitors could be hired by the Riverview college.

3. Types of depreciation used, i.e. it is the straight-line basis or WDV, as for WDV net cost for janitorial services might go down in the coming years

4. Quality control will be lost in case of outsourcing.

5. What would be the alternative in case of outsourcing company decided to call off the janitorial services, as in that case, Riverview college might have to again purchase the required equipment.