United Metal

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United Metal Case: Take-aways 1. There are two ways of approaching the Case: One could EITHER look at the ‘Cash flows for Make decision’ and ‘Cash flows for Buy decision’ separately and then compare them, OR look at the ‘Incremental Cash Flows from Make rather than Buy decision’ (in one go). Note that the above approaches would be appropriate only if the decision being made is the ‘Make vs. Buy’ decision. They would not be correct for deciding whether the company should make rather than do nothing (or buy rather than do nothing). The latter types of decisions would require a separate ‘with/without’ cash flow analysis which would incorporate differences in sales, the opportunity cost of the machine and initial inventory, and different figures for the chief operator and warehouse extension. 2. This raises the issue of problem boundaries. If the boundary of the problem is drawn around the department in question, as the manager responsible for the decision might be tempted to do, then problems will arise over the treatment of the chief operator. To maximise firm value, we should view the ‘boundary’ of the problem as the being the entire company, but also recognise that internal perspectives may not coincide with this. If the company continues to make the components, the other department will hire an operator at £7,000. If they switch to purchasing, the other department will hire the chief operator for £8,000. A similar ‘problem boundaries’ issue arises in the context of tax. What matters is the incremental impact the decision has on the company’s overall tax bill. Note that taxes are typically levied at the level of the company, and not on individual projects. What matters is whether the company is in a tax paying position or not. 3. Sunk costs should not be considered. The original purchase cost of the old machine and the initial year’s tax effect should be omitted, since these are sunk costs. Notice, however, that there will be a difference in the pattern of...
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