Problem-
Ajax Auto Upholstery Ltd. manufactures upholstered products for automobiles, vans, and trucks. Among the various Ajax plants around Canada is the Owlseye plant located in rural Alberta.
The chief financial officer has just received a report indicating that Ajax could purchase the entire annual output of the Owlseye plant from a foreign supplier for $37 million per year.
The budgeted operating costs (in thousands) for the Owlseye plant's for the coming year is as follows:
| Materials |
$15,000 |
|
| Labor |
|
|
| Direct |
$12,000 |
|
| Supervision |
4,000 |
|
| Indirect plant |
5,000 |
19,000 |
| Overhead |
|
|
| Depreciation - plant |
6,000 |
|
| Utilities, property tax, maintenance |
2,000 |
|
| Pension expense |
4,500 |
|
| Plant manager and staff |
2,500 |
|
| Corporate headquarters overhead allocation |
3,000 |
18,000 |
| Total budgeted costs |
|
$52,000 |
If material purchase orders are cancelled as a consequence of the plant closing, termination charges would amount to 10 percent of the annual cost of direct materials in the first year (zero thereafter).
A clause in the Ajax union contract requires the company to provide employment assistance to its former employees for 12 months after a plant closes. The estimated cost to administer this service if the Owlseye plant closes would be $2 million. $3.6 million of next year's pension expense would continue indefinitely whether or not the plant remains open.About $900,000 of labour would still be required in the first year after closure to decommission the plant. After that, the plant would be sold for an estimated $1 million. Utilities, property taxes, and maintenance costs would remain unchanged in the first year after closure, but disappear when the plant is sold.
The plant manager and her staff would be somewhat affected by the closing of the Owlseye plant. Some managers would still be responsible for managing three other plants. As a result, total management salaries would be about 50% of the current level, starting at closure and remaining into the future.
Required: Assume you are the company's chief financial officer. Perform a five-year financial analysis and make a recommendation whether to close the Owlseye plant on this basis. Provide support for and cautions about your recommendation with organized, clearly-labeled data. Use bullet points where appropriate.