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Park Square Chemicals

Report for Evaluation of Decisions

Park Square Chemicals

Report for Evaluation of Decisions

Contents

1.1.1.1.1.1.1.1 Introduction
1.1.1.1.1.1.1.2 Objective
1.1.1.1.1.1.1.3 Evaluations &
Findings
1.1.1.1.1.1.1.4 Considerations &
Concerns
1.1.1.1.1.1.1.5 Recommendations
& Outcomes
1.1.1.1.1.1.1.6 Conclusion
1.1.1.1.1.1.1.7 Appendixes
7.1

Appendix 1 calculation for decisions

7.2

Assumptions

7.3

Information needs

7.4

Glossary
1.1.1.1.1.1.1.8 References

Prepared by

Management Accountant

Park Square Chemicals

1.

Evaluation of Decisions

Introduction
This report consist of analysis for Park Square Chemicals (PSC) to evaluate the
decision whether to outsource its container manufacturing department
(decision Y) or to remain it status quo (decision X). Another alternative was
also considered in this report which is to maintain its current operation and to
outsource part of its activities (decision Z).

2.

Objective

2.1

Objective
The objective of this report is to assist the management to decide the value of
the available option.

This report will further support the management

through laying out the scenarios on both sides of the coin so that a precise
decision can be made.

3.

Evaluations & Findings

3.1

Based on the evaluation carried out there are a few findings which need to be
discussed before taking steps into decision making. As there are three options
considered in this project, an estimate cost for all options are presented in the
Appendix 1.
As per Appendix 1, it shows the total cost for all three options over the period
of five years. Decision X shows the total cost of continuing to make the
containers in the company.

This option will be set as a benchmark so

comparisons between options are compelling.

3.2.

Materials
Firstly, seeing that materials will only last a further three years, it is planned to
be replenished at year four at 900. The purchase of the new batch of putron
is more expensive compared to the previous. Conversely, matching up with
other options, the putron will be sold at 90,000 each. This generates extra
cash for PSC which is a plus point.

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Evaluation of Decisions

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3.

Evaluations & Findings (contd)

3.3

Labour
PSC will continue to pay the staff as per this years annual costs whereas for Y
and Z have a saving of 825,000 and 840,000 respectively. If PSC decides to
choose Y, it will still need to incur the cost for two of its staffs pension plan. It
costs 5,000 each per annum and this cost may carry on to a certain extent.
PSC may need to consider other substitutes if it wishes to look for a cheaper
alternative. For example, PSC may adopt the pension plans which might be
available for public by the government.

3.4

Departmental overheads
The managers salary will remain for in house because the machinery will still
be in operation so supervision is still required in this circumstance.

In

contrast, the other alternatives do not require any supervision therefore there
is saving in this context. Similarly, all other departmental overheads have the
same treatment.

Nevertheless, other expenses and general administrative

expenses (common cost1) are not avoidable because these costs need to be
incurred be it the final decision is to remain in house or outsource. The partial
outsource option then again, has a total saving of 10,000 annually because
only maintenance is in house so the number of staff can be minimised.

3.5

Other overheads
If the decision made is to either Y or Z, the machinery will be sold at 40,000
as the activity will be prolong by outsourcer. While the Company may choose
Y, of course there is a price to pay. The outsourcing company requires the
Company to pay for the annual contract and if PSC chooses Z, the contract is
expected to be less than the quoted price to fully outsource. The quoted price
is 300,000 per annum with a distinct maintenance fee of 87,500. In total it
adds up to 1,937,500 to outsource whereas Z is 1,500,000 for the extent of
five years respectively.

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See Glossary

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3.

Evaluations & Findings (contd)

3.6

All three alternatives have advantageous and disadvantageous. This will be


further discussed in the next section.

4.

Considerations & Concerns

4.1

Among all three options the Z gives the lowest costs due to the lower costs
incurred in terms of material, labour, departmental overheads and other
overheads. The contract price which was estimated to be 1,500,000 for the
period of 5 years is lower compared to Y. In total, Z gives PSC a saving of
35,000 for 5 years.
In contrast, Y costs the most at 2,133,750. The major cost lays on the contract
price besides this, all other costs have saving except the common costs 1. The
higher cost may be due to premium charged.

For example, Common

Containers (CC) may provide better service compared to the in house since
CC is specialise in this field.
4.2

Z is a better choice because of its lower cost. The benefit of Z is that PSC can
retain the most efficient. For instance, maintenance by in house is on the spot
thus minimising the idle time for the machine. CC is specialise in this field so
the container produced is expected to be higher quality furthermore this
allows PSC to focus on its core activity.
This creates a chain reaction based on the Balanced Scorecard 2 which will
affect PSCs financial and non financial performances. For illustration, the
better container produced by CC will lead to higher sales (financial
perspective) as PSC will be well known for its good quality (customer
perspective). The feedback from the customers will act as an indicator to the
management that PSC is doing well (business process perspective) and finally
with the extra revenue that PSC made will be used to train its staff for further
learning and growth (learning and growth perspective).

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1&2

Evaluation of Decisions

See Glossary

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Evaluation of Decisions

4.

Considerations & Concerns (contd)

4.3

However, decision Z can be demotivating to the staff because some of the staff
will be retrenched. This may cause the remaining staff to ponder whether
they will be lay off too. Another issue will be the lack of control by PSC. For
example, PSC may decide to make changes to its product with immediate
effect but with CC, they may need to discuss before any action is taken.
Privacy will be another problem in this area because CC may disclose the
method to produce or the component of the container.

5.

Recommendation & Outcome

5.1

Z is the best option available due to its lowest cost but it needs to cope with the
disadvantageous as mentioned above. These shortcomings can be overcome
by adopting the following recommendations.

5.2

The staff in PSC needs to be explained for the change that the Company is
currently going through (change management3). This will help the staff to be
assured with their job instead of deducing PSCs next move.

The method to respond to the lack of control in outsourcing can be better


managed by communicating with CC. For example, PSC needs to define to
CC its requirement. A better practice will be meeting up monthly to discuss
PSC subsequent requirements.

Finally, the lack of privacy can be overwhelmed by employing contract


between both parties. This will secure information of PSC to be within the
companies.

So far Z is the best choice however if the recommendations above are


implemented successfully PSC may want to try adopting decision Y although
it is a costliest choice. This can be considered because it creates extra value for
PSC (see 4.2)

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See Glossary

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6.

Evaluation of Decisions

Conclusion
In conclusion, outsourcing has become a norm in todays bazaar and its
importance cannot be denied. It is important for the management to think
thoroughly before making any decision but with the findings in this report,
undoubtedly Y is the best decision for PSC.

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7.

Appendixes (contd)

7.2

Assumptions

Evaluation of Decisions

The Appendix 1 was laid out with the assumptions that the all costs do not
change for the next five years. For example, CC may want to increase the price
of its contract to counter with the market conditions.
Another example would be the price of putron. As we can see, the price of
putron has increase from 750 to 900 in a years time. The increase of the
price may be due to scarcity. So there is no manner that we can predict how
the price of putron may fluctuate in future thus such assumption made.
In the context, it was also stated that CC will provide both production of
containers and maintenance of machinery in separate costs. Nevertheless, it
was not assured that CC will provide either one service because price quoted
may be presented as separated item but it may costs CC more to run operate
only one service thus causing disagreement. Therefore we can only assume
that CC will agree to run only one service.
7.3

Information needs
This report is composed with the best information it has. External factors like
the political views or inflations are not taken into consideration as this
information were insufficient. For example, the calculation in Appendix 1 was
not calculated by using the net present value 4 method. The computation does
not take in account of the time value of money, therefore, the total costs
worked out does not represent the true value of the cost.

Considerations like inflations or discounting rate to represent the risk PSC


encounter are also not included in Appendix 1 hence the costs do not denotes
its real value. This gives a vague view of the external factors.

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See Glossary

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7.

Appendixes (contd)

7.3

Information needs (contd)

Evaluation of Decisions

Internal wise, the management level may consider real options5. Besides the
alternative lay out, there may be better choices in the market. For instance, the
management may try to look for cheaper outsourcing companies or may as
well have companies to bit for the project. This will give the management
more alternative.

Similarly, with real options5 the management may want to look into their
competitors which also adopt the outsource plan for comparison purpose.
This at least gives the Company, an idea of how the Company will perform
before and after adopting the outsourcing plan. Once again, information is
very important in order to make the real options5 a success.

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See Glossary

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7.

Appendixes (contd)

7.4

Glossary

Evaluation of Decisions

Common costs

In process costing, those costs incurred by a process before the point at which
the joint products or by-products are subjected to separate treatment. The
common costs, therefore, must be borne by all the output, i.e. by the main
product, the joint products, and the by-products. (R. Hussey, 2005)

Balanced Scorecard

Performance measure which balances the internal (company) and external


(customer) against finances, innovation and learning. (Phil Robinson, 2006)

Change management

Change management means to plan, initiate, realize, control, and finally


stabilize change processes on both, corporate and personal level. Change may
cover such diverse problems as for example strategic direction or personal
development programs for staff. (Oliver Recklies)

Net present value

The process of calculating the value of an investment by adding the present


value of expected future cash flows to the initial cost of the investment; the
difference between the cost of an investment and the discounted present value
of all future earnings from that investment (Dictionary.com)

Real options

An option that arises naturally in the course of business activities rather than
one purchased on a financial market. A common example of a real option is
early investment in a technology, which will enable a firm to exploit the new
technology should it prove successful. (Oxford University Press, 2006)

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8.

Evaluation of Decisions

References
R.Hussey (2005) A Dictionary of Accounting.
Available at: http://www.highbeam.com/doc/1O17-commoncosts.html
(Accessed: 2 February 2010)

Phil Robinson (2006) The Business Performance Improvement Consultancy.


Available at: http://www.bpic.co.uk/jargon.htm#B
(Accessed: 2 February 2010)

Oliver Recklies Managing Change Definition und Phases in Change Processes


Available at: http://www.themanager.org/strategy/change_phases.htm
(Accessed: 2 February 2010)

Dictionary.com. Dictionary.com's 21st Century Lexicon.


Available at: http://dictionary.reference.com/browse/net present value
(Accessed: 2 February 2010)

Oxford University Press (2006) A Dictionary of Business and Management..


Available at: http://www.encyclopedia.com/doc/1O18-realoption.html
(Accessed: 2 February 2010)

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