X Company Is Planning To Drop A Department That Has Shown A

X Company Is Planning To Drop A Department That Has Shown A Loss Over

X Company is planning to drop a department that has shown a loss over the past few years. Its accountant estimates that the savings from dropping the department will be $18,700 a year for the next 6 years. The accountant also believes that the company will be able to immediately sell some equipment that was used in the department for $17,000. Assuming a discount rate of 5%, what is the net present value of dropping the department? X Company is considering outsourcing its email system. Total costs related to last month's in-house email operation, when there were 3,725 employee mailboxes, were as follows: Variable costs: Email license $18,625 Virus protection license $5,215 Miscellaneous $16,390 Fixed costs: Computer hardware $24,585. Of the computer hardware costs, $10,326 were common costs that will continue even if the email system is abandoned, and X Company will still need to pay for the virus protection license. Y Company has offered to operate an email system for X Company for $11.10 per mailbox. Next year, X Company estimates that 4,190 mailboxes will be required per month. By how much will X Company's monthly profits change if they decide to outsource its email service to Y Company instead of managing the service internally? [A positive number indicates that in-house costs exceed outsourced costs; a negative number indicates that in-house costs are less than outsourcing costs.]

Paper For Above instruction

Introduction

The decision-making process in managerial accounting often involves evaluating whether to continue or discontinue a department or service based on its financial performance and strategic fit. This paper explores the specific case of X Company's consideration to drop a loss-making department and outsource its email system, analyzing the financial implications of these decisions using net present value calculations and cost comparisons.

Part 1: Valuation of Dropping the Department

The initial step involves calculating the net present value (NPV) of dropping the department. The projected annual savings are $18,700 over six years, with an immediate equipment sale value of $17,000. Given a discount rate of 5%, the present value of the savings needs to be computed, factoring in the equipment sale.

The present value of an annuity (annual savings) over 6 years at 5% discount rate is calculated using the formula:

PV = P × [1 - (1 + r)^-n] / r

where P = $18,700, r = 0.05, n = 6.

Calculating this, PV = $18,700 × [1 - (1 + 0.05)^-6] / 0.05

PV ≈ $18,700 × 4.3295 ≈ $81,041.65

Adding the immediate equipment sale:

Total NPV = PV + equipment sale = $81,041.65 + $17,000 ≈ $98,041.65

This positive NPV indicates that dropping the department is financially advantageous.

Part 2: Cost Analysis of In-House vs. Outsourcing Email System

Next, we analyze the costs associated with maintaining the email system internally against outsourcing, considering the projected number of mailboxes and costs involved.

Internal Costs:

- Variable costs:

- Email license: $18,625

- Virus protection license: $5,215

- Miscellaneous: $16,390

- Fixed costs:

- Computer hardware: $24,585, but $10,326 are common costs that will persist regardless of the decision.

Total relevant fixed costs for in-house operation are: $24,585 - $10,326 = $14,259, plus the virus protection license, totaling $19,474.

Outsourcing Costs:

- Price per mailbox: $11.10

- Expected mailboxes next year: 4,190 per month

Monthly costs for outsourcing:

$11.10 × 4,190 = $46,569

Total monthly costs for in-house operation (variable + relevant fixed):

Variable: $18,625 + $5,215 + $16,390 = $40,230

Fixed (excluding common costs): $14,259

Total relevant in-house costs: $40,230 + $14,259 = $54,489

Difference in monthly costs:

In-house: $54,489

Outsourcing: $46,569

Monthly profit change:

$54,489 - $46,569 = $7,920

A positive value indicates that outsourcing will save approximately $7,920 per month compared to managing the email system internally.

Annualized impact and strategic considerations further reinforce outsourcing as an effective cost-saving strategy, especially considering future projections and potential benefits such as reduced management overhead and scalability.

Conclusion

The financial analysis indicates that discontinuing the loss-making department would yield a positive net present value of approximately $98,042, signifying a financially sound decision. Simultaneously, outsourcing the email system could reduce monthly costs by about $7,920, which translates into significant annual savings and operational efficiencies. These strategic moves could enhance overall profitability and focus management efforts on core business activities.

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