Question

State University is considering hiring an outside company for its grounds maintenance. In this regard, State University has received a bid from Mackin Services. Mackin states that its bid of $410,000 will cover all services and planting materials required to "keep State University's grounds in a condition comparable to prior years." State University's cost for grounds maintenance in the preceding year was $412,000 as follows: Salary of three full-time gardeners Plant materials Fertilizer Fuel Depreciation of other equipment Depreciation of tractor and mowers Total $295,000 80,000 9,000 8,000 5,000 15,000 $412,000 If State University hires Mackin, it will be able to sell its other equipment for $30,000, and the three gardeners will be laid off. What is the first year financial impact of hiring the outside company for its grounds maintenance?
a. $30,000 savings
b. $13,000 additional
c. cost $2,000 savings
d. $12,000 savings

Answer 1

Answer:

The correct option is D, savings of $12000

Explanation:

The first year financial impact of hiring outside company for grounds maintenance can be calculated by examining relevant costs  for both alternatives.

Relevant costs to the University of handling the maintenance is given as;

Salary of full-time gardeners   $295,000

Plant materials                           $80000

Fertilizer                                       $9000

Fuel                                                $8000

Total relevant costs                     $392000

The relevant costs of outsourcing the services is given below:

Mackin services                                     $410000

Proceeds from disposal of equipment ($30000)

Relevant costs                                          $380000

The savings by choosing the latter is         $12000( $392000-$380000)

Please note the cost of equipment is not a relevant cost as it is a sunk cost.