Question

Harlan Bikes wants to close an unprofitable division with an expensive mortgage, high advertising costs, and high raw material costs. Harlan estimates annual savings of $450,000 if it closes the division versus an annual loss of $235,000 if it keeps it. How do the quantitative factors involved in this decision differ from the qualitative factors?

Answer 1

Answer:

Quantitatively, Harlan Bikes is justified in deciding to close the department, but there are other qualitative factors that need to be considered which may result in the company loosing much more that they can save if the department is closed, such as for example a decrease in employee morale, a negative signalling effect to other stakeholders, a drop in sales in related products etc.

Explanation:

A decrease in employee morale can result especially if workers  in other departments are no-longer sure about their future in the company, resulting from fears of their departments being closed. This can negatively affect productivity resulting in lower profits in other department.

A negative signalling effect means that other stakeholders such as investors and creditors may start questioning managements ability to profitably run the business, and the company will be perceived as more risky. Cost of debt and cost of equity capital for example, may go up, due to this higher perceived risk, and  which may reduce the number of positive net present value projects that the company can undertake due to an increase in cost of capital.

If the company carries related products in other departments, it may also see a drop in sales in those sales, which will effectively reduced the savings that are estimated  to be gained from closing the division.

Answer 2

The quantitative factors involved in the decision to close the unprofitable division are:

1. cost savings. The business would not have to spend on advertising, mortgage and raw materials.
2. increase in the annual savings. The business would save $450,000.

The qualitative factors involved in the decision to close the unprofitable division are:

1. reduction in morale of other employees as a result of the closure of a branch. If a division is closed, employees may become discouraged and this would reduce output.
2. negative signalling to investors. This can lead to an increase in the cost of borrowing if investors believe that Harlan Bikes is in crisis as a result of closing a division.

Qualitative factors are factors that are difficult to measure or predict. On the other hand, quantitative factors are factors that can be measured with a degree of accuracy.

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