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Overview
Synopsis of case Definition of Problem Possible Alternative Solutions Evaluation of Quantitative Factors Evaluation of Qualitative Factors Recommendations
Synopsis of Case
Baldwin Bicycle Company (BBC) has been making above average bicycles for almost 40 years Hi-Valu Stores Inc. (HVS) has approached BBC to produce a house-brand of bicycles for them Hi-Valu wants the Challenger to look different and cost less than Baldwin's regular line Preliminary financial analysis of the proposal is needed
Problem Statement
The Hi-Valu offer represents a chance for BBC to increase production capacity but at a greater cost per unit than its current product.
Alternative Solutions
Because the quantity and buying price put forth by Hi-Valu are non-negotiable, and assuming that laying off the excess capacity is not a possibility, the number of alternatives are limited: Reject the proposal/maintain status-quo Accept the proposal
Quantitative Factors
In conducting preliminary financial analysis, Suzanne Leister must consider quantitative elements in order to determine which alternative would be most financially beneficial to BBC These include:
Differential revenues Differential costs
Cost of sales, one-time costs, asset-related costs, tax expenses
Differential profit
Balance Sheets
Base case balance sheet:
Assets Cash Accounts receivable Inventories Plant and equipment (net) $342,000.00 $1,359,000.00 $2,756,000.00 $3,635,000.00 $8,092,000.00 Liabilities and Owners' Equity Current Liabilities $3,478,000.00 Noncurrent liabilities $1,512,000.00 Total liabilities $4,990,000.00 Owners' equity $3,102,000.00 $8,092,000.00
Liabilities and Owners' Equity Current Liabilities $4,011,402.00 Noncurrent liabilities $1,512,000.00 Total liabilities $5,523,402.00 Owners' equity $3,102,000.00 $8,625,402.00
Income Statements
Base Case: Sales revenues Alternative (Year 1): Sales revenues Baldwin name Challenger name Total sales revenue Cost of sales Baldwin name Challenger name Total cost of sales Gross margin Other Expenses Other differential costs One-time added Asset-related costs Income before taxes Income tax expense Net income $10,674,900.00 $2,307,250.00 $12,982,150.00 $7,899,151.00 $2,097,500.00 $9,996,651.00 $2,985,499.00 $2,354,000.00 $5,000.00 $95,379.00 $531,120.00 $244,786.81 $286,333.19
Gross margin Other expenses Other differential costs One-time added Asset-related costs Income before taxes Income tax expense Net income
Differential Revenues
Differential revenues: those revenues that are different under one set of conditions than they would be under another Conduct a comparison of the projected revenues for the base case scenario (reject proposal) and the alternative scenario (accept proposal)
Differential Revenues
Reject Proposal Projected sales:
100,000 bikes
Unit price:
$110.05
Unit price:
$110.05 $92.29
Sales revenue:
$11,005,051
Sales revenue:
$12,982,150
Differential Costs
Differential costs: those costs that are different under one set of conditions than they would be under another
Conduct a comparison of the projected costs for the base case scenario (reject proposal) and the alternative scenario (accept proposal)
Differential Costs
Reject Proposal Unit cost:
$81.43
Cost of sales:
$8,143,454
Cost of sales:
$9,996,651
Asset-related costs:
$95,379
Questions 1-4
1.What is the expected added profit from the Challenger line? 2.What is the expected impact of cannibalization of existing sales? 3.What costs will be incurred on a one-time basis only? 4.What are the additional assets and related carrying costs?
Profit from yrs. 2 and 3 increases, from yr. 1, by $2,696 resulting in a total differential profit of $15,377
Expenses Income Before Taxes Income Tax Expense
Cannibalization
Cannibalization: to deprive of vital elements or resources, such as personnel, equipment, or funding, for use elsewhere The impact of cannibalization is the 3000 less Baldwin bikes expected to be sold, plus the uncertainty of the success of the Challenger line of bikes
One-time Costs
The one time costs that are incurred are the $5000 associated with the preparations of drawings and designs and procuring sources for fenders, seats, handlebars, tires, and shipping boxes
Question 5
What is the overall impact on the company in terms of (a) profits, (b) return on sales, (c) return on assets, and (d) return on equity?
Ratio Analysis
Profit Return on sales Return on assets Return on equity Profit Return on sales Return on assets Return on equity 1988 $255,000 2.35% 3.15% 8.22% Base case Year 1 $273,652 2.49% 3.37% 8.82% Base case Years 2 & 3 $273,652 2.49% 3.37% 8.82% Alternative year 1 $286,333 2.21% 3.32% 9.23% Alternative Years 2 & 3 $289,029.00 2.23% 3.35% 9.32%
Qualitative Factors
A decision cannot be based solely on numerical analysis While numbers may appear favourable, it is imperative to consider the unmeasurable factors
Qualitative Factors
While calculations are useful in narrowing down alternatives that should be considered, qualitative analysis assists in making the final judgement For each alternative there are associated risks and rewards
Question 6
Reject Proposal
Risks BBC may face continually declining sales due to a poor economy BBC will continue to produce at only 75% production capacity Rewards Maintain loyalty from current distributors Maintain 40-year reputation for above average quality and price
Question 7
Recommendations
Because there is a lack of research conducted regarding the new Challenger line, uncertainties exist as to how it will fare in the market However, because of the poor state of the economy accepting the proposal from HVS is a good idea for BBC
Raise production capacity from approx. 75% to approx. 97% Increase in Challenger sales could offset decreasing Baldwin sales
Recommendations
The condition of the economy is unlikely to improve in the short term, therefore taking a risk on a three year contract that projects favourable sales promises a better situation than they are currently facing Based on the information given, Baldwin Bicycle Company should accept Hi-Valu's proposal
Thank You!