Question

8-11 Outsourcing (LO 3)

Merit Bay Communications operates a customer call center that handles billing inquiries for several large insurance firms. Since the center is located on the outskirts of town, where there are no restaurants within a 20-minute drive, the company has always operated an on-site cafeteria for employees. The cafeteria uses $180,000 in food products each year and serves 5,000 meals per month, at a price of $5 each. It employs five workers whose salaries and benefits total $90,000 per year. Depreciation on the cafeteria equipment is $35,000 per year. Other fixed overhead that is directly related to operating the cafeteria totals $12,000 per year.

     Best Ever Foods has offered to take over Merit Bay’s cafeteria operations. As part of the transition, current cafeteria employees would become Best Ever employees, and Best Ever would assume all out-of-pocket costs to operate the cafeteria. Best Ever would continue to offer meals at $5 each and would pay Merit Bay $0.50 per meal for the use of its cafeteria facilities.

Required

a.    Should Merit Bay continue to operate the employee cafeteria, or should the company accept Best Ever’s offer? Why?

b.    Assume that Merit Bay accepted Best Ever’s offer two years ago and that all costs have remained constant. Since then, a new shopping mall has opened close to the company’s location, bringing in several fast-food and quick-service restaurants. Employee demand for cafeteria service has dropped to 1,000 meals per month, and Best Ever has laid off two of the five cafeteria workers. Does it make financial sense for Merit Bay to renew Best Ever’s contract for another year, or should it resume operation of the cafeteria operation?

Answer 1

If Merit Bay continue to operate the employee cafeteria
Food product cost	180000
Employee cost	90000
Other Fixed cost	12000
Depreciation on the cafeteria equipment	35000
Total costs	317000
Revenue (5000*12*5)	300000
Total loss if Merit Bay continue to operate the employee cafeteria	17000
If Merit Bay should accept Best Ever’s offer
Depreciation on the cafeteria equipment	35000
Revenue for renting facilities (5000*12*0.5)	30000
Total loss if Merit Bay should accept Best Ever’s offer	5000
Action: Merit Bay should accept Best Ever’s offer because Total loss is lower compared to continue to operate the employee cafeteria.
Does it make financial sense for Merit Bay to renew Best Ever’s contract for another year, or should it resume operation of the cafeteria operation?
If Merit Bay should it resume operation of the cafeteria operation
Food product cost (180000*1000/5000) - variable cost	36000
Employee cost (5-2 laid off =3) (90000*3/5)	54000
Other Fixed cost	12000
Depreciation on the cafeteria equipment	35000
Total costs	137000
Revenue (1000*12*5)	60000
Total loss If Merit Bay should it resume operation of the cafeteria operation	77000
If Merit Bay should Merit Bay to renew Best Ever’s contract for another year
Depreciation on the cafeteria equipment	35000
Revenue for renting facilities (1000*12*0.5)	6000
Total loss if Merit Bay should accept Best Ever’s offer	29000
Action: Merit Bay should Merit Bay to renew Best Ever’s contract for another year because Total loss is lower compared to continue to operate the employee cafeteria.