Prepare a report for Pitlochry Polymers indicating a) which of the available options they should pursue.

Corporate Finance Assignment

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Pitlochry Polymers is a small United Kingdom Company founded in 1965. Its listed on the UK AIM. It manufacturers and markets a range of specialist chemicals to the oil extraction and refining industry mainly to companies operating in the North Sea fields. Its products are comparatively expensive and require delicate handling if they are to be effective in use. They require careful packing and the company have always made a feature of the special properties of the containers used. These had a patented lining made from a material known as BWF, and Pitlochry Polymers operated a department especially to maintain its containers in useable conditions and to manufacture replacement for those that were damaged beyond repair. Mr Atholl was the production manager and he had suspected for some time that the company could save money, without any loss of quality by buying the containers from an external supplier. He has approached a specialist supplier Dunkeld Ltd and asked them to tender for the work involved. As part of the same exercise he has asked Mr Wallace, the chief accountant to let him have a statement of costs of running the containers department. A few days later the tender from Dunkeld Ltd arrived. They indicated that they were able to supply all the new containers required, currently 3000 per year, for £250000 with the contract to run for a guaranteed five years period and to be renegotiated after that period. Should the current number of containers required be increased, the tender price would be increased proportionally. Dunkeld offered, irrespective of whether the manufacturing tender was accepted or not, to carry out any maintenance work on containers, short of complete replacement, for a total of £75000 per year on the same contract terms. Mr Atholl had been provided with the cost figures for the container department for the past 12 months and these are reproduced below. £ £ Materials 140,000 Direct labour 100,000 Departmental overheads: Supervisors salary 16,000 Rent 9,000 Depreciation of machinery 30,000 Maintenance of machinery 7,200 Other expenses 31,500 93,700 Allocated central overheads 333,700 45,000 378,700 Pitlochry Polymers -Case Study Page 3 A quick comparisons of the tender from Dunkeld Ltd against current internal costs had convinced Mr Atholl that no time should be lost in closing down the container department and contracting with Dunkeld Ltd to supply the containers. However before going further he felt it appropriate to give the supervisor of the department, Mrs Johnston an opportunity to question his conclusions. He therefore called her to a meeting and laid the facts before her at the same time making it clear that her own job was not at risk even if the department was closed as there was another vacancy becoming available at the same grade which she could take up without loss of pay or prospects. Mrs Johnston was unconvinced and asked for time to think the matter through. The following morning she asked to see Mr Atholl and said she thought there were a number of considerations that should be borne in mind before any decisions were made. “For instance” she said, “what will we do with the machinery? It cost us £240,000 only four years ago, is working perfectly, but we’d be lucky to get £40,000 for it now even though there’s at least another four years life left in it. If we were to continue production though, after the four years were up we wouldn’t buy replacements. We can lease it for £30,000 on annual lease terms and that’s what we’d do. We’d still be responsible for any annual maintenance charges though. Then there’s the stock of BWF (the specialist chemical) we bought a year ago because we were unsure of supply. That cost us £200,000 and we’re only used 20% of it so far. At our current rate of usage we’re got four years supply left. Wallace’s figures of £140,000 for materials probably included about £40,000 for BWF. But if we don’t use it we’ve got a problem because it’s difficult to handle. We bought it for £1000 a ton, but the minimum price you could get it for today is at least £1200 per ton. Selling it would incur a lot of expenses, if we could find a buyer, and after expenses we’d only end up with, at best, £800 a ton. Atholl wanted Wallace present at this discussion as financials were his territory so he called him in and put Mrs Johnston’s points to him. “I don’t much care for this conjecture and hypothesising. “Wallace commented “My figures are based on fact and are objective and conclusive as far as I’m concerned. If we’re going to have all this discussion of what might happen we need to think of the problem of space. We’re currently paying £17,000 a year to rent some storage space a couple of miles away. If we close the container department we’d have all the space we need and some left over here on the main site, with no need to rent any” “Good point” commented Atholl, “though I’m a bit worried about our employees if we close the Department. Apart from Mrs Johnston we couldn’t redeploy them anywhere else in the business. I could investigate whether Dunkeld would take any of them on, but some of them are getting on in years. Look at McEwan and Stewart for example – they’ve been with us since they left school forty years ago. If we let them go we’d have to give them a small pension to supplement their income – say £3,000 a year each. Pitlochry Polymers -Case Study Page 4 Mrs Johnston felt relieved at this “But I still don’t like Wallace figures ”she said “what’s this £45,000 central overhead allocated - you don’t expect to sack anyone at head Office if we close my department down.” “No”, said Atholl “almost certainly not but someone has to bear these costs. We can’t simply ignore them – they’re real. When we look department by department we can’t ignore central overheads, - they’ve got to be recovered if we expect to make a profit.” “There is another alternative, said Atholl. “Why don’t we consider keeping on the maintenance work ourselves and let Dunkeld supply new containers only. What do you think Mrs Johnston?” “It’s worth a look at, certainly” said Mrs Johnston. “We wouldn’t need the machinery and we could promote a current employee to a managerial grade to run the unit so that I didn’t do it. That would save £6,000 per year. You’d only need about 20% of the current workforce, so keep the oldest and most experienced. We would still need all the space so we’d be paying the same for rent. “And what materials would we use?” asked Atholl. “We use about 10% of the total on maintenance” answered Mrs Johnston “But we would have other expenses still, and these would come to about £13,000 a year I would guess”. “I’ve told Dunkeld they will have an answer next week so we’ll need to do a bit more work on this so I’d like you two to get your heads together and look at these numbers closely. The date for the decision is 28th February 2017 Required: Prepare a report for Pitlochry Polymers indicating a) which of the available options they should pursue. 60 marks b) other issues which management should take into account before proceeding. 40 marks Total 100 marks

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