Cathy and Zoe established their business, ATOM Ltd (ATOM),

Cathy and Zoe established their business, ATOM Ltd (ATOM), to produce motors for electric lawn mowers. Recently, they received a bid from a supplier offering to sell them rotors, an essential component of electric motors that ATOM currently produces in-house. The offer is for 5,000 motors per year at $90 each. Cathy and Zoe estimate the costs of producing one rotor in-house as follows:

Fixed overhead costs include both rent and depreciation on the machinery, which are considered unlikely to be change within the relevant range.

In response to the offer, Cathy and Zoe commissioned a study to investigate whether any fixed overhead costs could be reduced. This study found that purchasing 5,000 rotors per year could:

• Avoid one setup, which would reduce total spending by $10,000.

• Allow one inspector to be laid off, saving $50,000.
• Allow one person in materials handling to be laid off, saving $20,000.
• Reduce engineering work by 50 hours at $35 per hour. However, the engineer currently allocated to the rotor production line would be re-assigned.

Cathy and Zoe have asked you, a management consultant, to advise them on whether to accept the supplier’s offer.

REQUIRED:

A management report to Atom Ltd that includes the following:

(Report style = 10 marks)

a) A determination of whether, on financial grounds alone, the rotor should be produced internally or purchased from the supplier

(i) if no changes are made; and

(ii) if all the suggested changes are made;

Show full calculations.

b) A discussion of any TWO qualitative factors, including strategic implications, that should be taken into acccount before making a decision;

c) Reviewing the study, Atom Ltd’s finance manager makes the following remark:

“This study ignores the additional activities that purchasing the rotor would cause. For example, although we’d no longer need to inspect the rotors on the production floor, we would need to inspect them as incoming parts in the receiving area instead. I’m not convinced we’ll actually save anything at all on inspection costs.”

Comment on this remark and whether you think it is reasonable;

d) Your recommendation/s to Cathy and Zoe on whether Atom Ltd should accept the supplier’s offer or continue to produce the rotors itself.