Reference no: EM132768584

Question - Compute a cash flow analysis of the incremental costs of outsourcing versus not outsourcing based on the attached case study.

Lee is looking to outsource production. Krish's advisory firm charges 2% of initial year's contract price, each year, for the duration of the outsourcing contract. The outsourcing firm sent an offer sheet quoting an annual fee for five years of CAD743,000 for the first year, escalated by 2% each year thereafter. If Lee's firm (LOPP) signs an oursourcing agreement in the near term, Lee plans to do the following:

1. Sell the outsourced functions' office furniture, two vehicles, and special 3D printing equipment as soon as possible. He estimated he can get CAD77,500 for it all now. Combined, it had originally cost the company CAD122,500 two years ago. At the moment, and on average, it all had a remaining depreicable life of five years with an estimated zero salvage value. The company depreciated all its fixed assets on a straight-line basis.

2. For the first couple of years of any outsourcing arrangement, Lee will dedicate 10% of his time to overseeing the outsourcing relationship.

3. If LOPP moved ahead with outsourcing, 6 employees will lose their jobs. Two of the six were owed severance totaling CAD78,000 that is to be paid at the end of their first year of their release. The other released employee do not get severance.

4. A seventh employee, currently salaried at CAD80,000 would be affected by outsourcing - his job would no longer be need. Lee decided, for the foreseeable future, that person would not be released (he was a cousin). Lee will find "special projects" for him to do.

5. There was a final employee Lee had to consider - the administrative supervisor, James Black - who would no longer be needed in that capacity. LOPP had created a new managerial position advertised at CAD100,000 and Lee had expected to pay that. He felt sure, however, Black would accept the new position at his current compensation level of CAD90,000. Lee would reconsider his base compensation level at a later date.

6. In the floor space vacated by the potentially outsourced functions, Lee planned to move the company's small design studio from across the street, filling about half of the free-up space. LOPP was currently paying rent of CAD25,000 a year for the space and it was fixed for the next five years. He had received an estimate of CAD4,000 from a moving company to make the move over one long weekend so as to minimize the disruption to the various client projects underway. With the in-house vacated space, Lee wondered if it would make sense to sublease to a small business. He estimated he could get CAD60,000 in annual rent. He acknowledged he might have to spend about CAD11,000 in cleaning, painting, repairs, and modest upgrades to get it ready for the new tenant.

7. Lee thought he could convince the outsourcing firm to buy special brochures he already had on hand at contract signing for CAD17,000 even though those materials were currently carried on the books at their original production cost of CAD19,000.

8. Lee felt a reasonable estimate of LOPP's future combined provincial and federal corporate income tax rate would be 25%. Employees would probably get a 5% annual raise over the foreseeable future. All other costs (generic and special materials) would escalate at 4% annually.