Question

Wang Production Systems ("Wang) provides production monitoring systems to businesses throughout North America. It has been approached by Shah Associates to provide and manage Shah's production systems under a three year contract. Shah has production facilities throughout North America. Shah has obtained several bids and is unprepared to pay more than $60/hour for these services. In order to take on the contract, Wang would need to establish a new call center dedicated to Shah's business. The monthly rent for the new space would be $5,000, including all utilities. Required equipment, furnishings and computers/phones would cost $35,000; these items would collectively have a salvage value of $5,000 at the end of the contract and would have no further use to Wang at that point. The call center would be managed by an outside service company, which expects to bill 1,800 hours per year at a rate of $125/hour. Ten additional employees would be hired by Wang at an average hourly rate of $25, plus benefits equal to 50% of the hourly rate. Each employee is expected to work 2,000 hours per year. Wang expects to bill Shah 20,000 hours per year for management of the call center. 1. Should Wang accept the contract with Shah based on these facts? Why or why not? Show your calculations. 2. Are there any other factors Wang should consider?

Answer 1

Answer to Question 1.  

Total Billing for 3 years : $60/ hour x 20,000 hours x 3 years = $3,600,000

(-) Rent and utilities for 3 years : $5000 x 12 months x 3 years = $180,000

(-) Equipments..etc - Salvage Value : $35000 - $5000 = $30,000

(Assumed that all equipments/phones etc are used only to provide services to Shah Associates)

(-) Outsourcing of Call Centre : $125/hour x 1800 hrs x 3 years = $675,000

(-) Employee cost : 10 employees x 2000 hrs x 3 yrs x $37.5 = $2,250,000

($25 hourly rate + 50% benefits of $25 = $37.5)

Estimated Income from accepting the three year contract = $465,000

Hence, Wang should accept the contract with Shah Associates as it will result in a profit of $465,000 over 3 years.

Answer to Question 2.

Yes, Wang should also consider the quality affected if services are outsourced to some other company to handle the call centre.

Also, The ten additional employees hired will lead to fixed cost of salary and benefits after the termination of 3 year contract with Shah Associates.