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• Problem 1

Jack Smith, owner of Jack’s Auto Sales, is deciding whether his company should process its own
auto loan applications or outsource the process to Loans Etc. If Jack processes the auto loan
applications internally, he faces an annual fixed cost of $2500 for membership fees, allowing
him access to the Top Notch credit company, and a variable cost of $25 each time he processes a
loan application. Loans Etc. will process the loans for $35 per application, but Jack must lease
equipment from Loans Etc. at a fixed annual cost of $1000. Jack estimates processing 125 loan
applications per year. What do you think Jack should do?

(a) Should Jack process the loans internally or outsource the loans if demand is expected to be
125 loan applications?

(b) Is Jack indifferent to internal processing and outsourcing at one level of loan applications?

• Problem 2

Big State University (BSU) is considering whether or not it should outsource its housekeeping
service. Currently, BSU employs 400 housekeepers at an average annual wage of $23,000 plus
another 39 percent for fringe benefits. Annual fixed costs associated with housekeeping are
$1,278,800. Eric’s Efficient Cleaners (EEC) will provide similar housekeeping for a fixed annual
cost of $7,500,000 plus a variable cost of $20,000 per housekeeper required. Because Eric uses
state-of-the-art equipment and well-trained employees, his company would need only 80 percent
of the current BSU housekeeper staff (or 320 housekeepers).

(a) Calculate the annual cost of BSU using its current housekeeping staff.

(b) Calculate the annual cost if BSU lets EEC do the housekeeping.

(c) Find the indifference point for the two alternatives.