You are an accounting consultant with Numbers-R-Us LLP, a firm of independent accounting and management consultants. You have been asked by one of your clients – Ms. Roberta Chavner, the president of STARK Widgets Inc. in Orillia, Ont. – for some advice. Note: Ms Chavner has a solid accounting background but relies on your professional judgement.
STARK Widgets manufactures 750,000 kronks a year. Kronks are metal parts which are used in making widgets; one kronk is included in each widget. STARK uses these kronks to make the widgets it sells to customers across Canada.
STARK has been approached by Dr. Linus Monk, the president of Monk Kronks Corp., a manufacturer of kronks. Dr. Monk has offered to sell kronks to STARK for $10 each (including the shipping costs). Monk could ship the kronks to STARK within one week of the order, and offers a two-year warranty on each kronk. Dr. Monk has guaranteed the price for two years.
Currently, STARK makes the kronks in a specially-designed area in its factory in Orillia. Each kronk costs $14 to make (see the summary at the end of this document). Ms. Chavner wants you to recommend whether STARK should buy the kronks from Monk or continue to make the kronks itself.
You gathered the following information in your research. Some of the data may be useful in your decision; some may be irrelevant.
• STARK sells its widget at prices between $65 and $75 each. STARK’s main competitors charge between $45 and $55. STARK can charge higher prices because it offers the highest-quality widgets, a five-year warranty, and delivery within two days of the order.
• STARK currently sells 750,000 widgets a year. STARK’s profit on each widget is $20.
• In response to its customers’ requests, STARK designs several new models of widgets each year. Each new widget design requires some modifications in the kronks. Monk can make these design changes at no cost if it is given one month’s notice.
• Kronks are large, and take up a lot of storage room. Therefore, STARK makes kronks in small batches as they are needed.
• If STARK buys widgets from Monk, the factory space used to make kronks will not be used. STARK can save about $50,000 a year in heating and electricity costs if it shuts down this part of the factory; total heating and lighting costs for the entire factory average $300,000 a year.
• If STARK buys the widgets, it will lay off the six long-time employees responsible for making the kronks, each of whom earns $50,000 annually. The one-time severance cost will be $120,000.
Ms. Chavner does not believe that any other labour costs will change.
• The machinery used by STARK to make kronks was bought in 2010 for $1,500,000. It has an expected useful life of 15 years, with no disposal value after that. STARK believes it can sell the machinery to another widget manufacturer; the net proceeds would be $150,000.
• Monk Kronks Corp. is well-known for making better-than-average kronks in large quantities. It has been in business for 20 years.
REQUIRED:
Write a brief letter to Ms. Chavner making your recommendation. Make up any addresses or other information you need to design a one-page proper full-block format letter. Submit your letter as a Word document in Blackboard.
