Jake Chemicals – Short-Term Decision Making
“If these new products are to be competitively priced, we have got to do something about our container costs” said Mr. Walsh. Walsh is the general manager of Jake Chemicals which manufactured and sold a range of high-grade chemical products. These products required careful packing and the company made a special feature of the properties of the containers used. They used patented lining made from a material known as GHL, and the firm operated a department especially to maintain its containers in good condition and to make new ones to replace those that were past repair.
“I believe that we can achieve substantial economies if we buy our containers from an outside source” continued Walsh. “I have been making some inquiries and it appears that Packages would offer us a contract, for five years certain, to keep our containers in good repair and to make all the containers we are planning to need. This would cost £500,000 per year and I believe they would offer us as good a service as we could get elsewhere, or by doing the job ourselves. The equivalent cost of doing it ourselves is £578,000 per year so that over a five year period we would save nearly £400,000 if we make the change now.”
The £578,000, which Walsh quoted was made as follows:
Manager’s salary 34,000
Depreciation of machinery 33,500
Maintenance of machinery 10,500
Other expenses 42,500
Proportion of general administrative overheads 67,500
Mr. Duffy, the manager of the containers department, looked thoughtful and asked for time to think the matter over. The next morning he asked to speak to Walsh again, and said he thought there were a number of points that ought to be borne in mind before his department was closed. “For instance”, he said, “we would have to scrap the machine. It cost us £360,000 three years ago, but there isn’t a market for second-hand equipment of this type and you’d be lucky if you got £50,000 for it now, even though it’s good for another five years. And then there’s the inventory of GHL (the special chemical) we bought a year ago. That cost us £150,000. We used up about third of it last year. The material cost you quoted yesterday (£200,000) probably includes about £50,000 for GHL.
We bought it for £1,500 a ton, and you couldn’t buy it today for less than £1,800, but it is tricky stuff to handle and if you sold it you wouldn’t have more than £1,200 a ton left after handling expenses have been allowed for.” Walsh admitted that Duffy had raised a number of points that ought to be borne in mind. He also pointed out that Duffy need have no fear of redundancy because, if his department were closed, he would be moved to another managerial post which was shortly becoming vacant, without loss of pay or prospects. Duffy seemed relieved to hear this, but said that he was worried about the workers in his department. “Perhaps you could see if Packages would take some of them on”, he said “but otherwise I am afraid I cannot see them fitting into any of our other sections without considerable retraining.” Walsh agreed and said he would see what could be done. He went on, “Of course the closure of your department would release much needed space. At the moment we are renting outside warehouse space which is costing us £45,000 a year. The closure of your department would mean we would have all the additional space we need without outside renting.”
“Do you think there would be any saving in general administrative overheads?” asked Duffy. “As you know, I am being charged £67,500 a year for this service from Head Office.”
“Probably not” said Walsh, “but remember that someone will still have to pay for these
costs and we can ignore them in our calculations. Well, I think we have thrashed this out pretty fully. This has been a useful discussion. I will let you know what I decide by the end of the week.”
1. From the information given in the case, if Walsh signs with Packages will Jake
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