You are on page 1of 30

Management

Accounting

CASE 26-4

BALDWIN BICYCLE
COMPANY

OUTLINE

1. Background
2. Statement of the Problem
3. Objectives
4. Alternative Courses of Action
5. Data Pertinent to Hi-Valu Proposal
6. Analysis
7. Conclusion

Background
BALDWIN BICYCLE COMPANY:
Ms. Susan Leister, Marketing VP
Baldwin Bicycle Company (BBC) had been in the
business for almost 40 years manufacturing above
average (quality and price) bicycles
In 1989, BBC lines includes 10 models ranging from
small beginners model to 12-speed adults model
Current annual sales of about US$10 million
Sales generated from independently owned toy stores
and bicycle shops. BBC had never before distributed
its product through department
Current operation of BBC is at 75% of one-shift
capacity

Background
HI-VALU COMPANY
Mr. Karl Knott, buyer
Hi-Valu Stores, Inc. operates a chain of discount
department stores
Hi-Valu Stores sales volume has grown to the
extent that it was beginning to add house
brand/private label merchandise to its product
lines

Background
THE PROPOSAL
Hi-Valu approached BBC to produce bicycles for the chain
bearing the name Challenger, to be priced lower than
their named brands.
Hi-Valu wanted the bikes different from the usual BBCs
existing models.
Hi-Valu wanted to hold the units on consignment in its
own warehouse and withhold payment until delivery to a
specific store. Hi-Valu would agree to take title to any
bicycle that had been in one of its warehouses for four
months, again paying it within 30 days.
Hi-Valu proposal is for a 3-year period, contract would be
automatically extended on a year-on-year basis, with at
least 6 months notice if the contract will not be extended

Background

CURRENT STATE OF THE MARKET


Bicycle boom has flattened out
Poor economy had caused BBCs volume to fall in
the last 2 years
Expected sales volume of BBC for the next 3 years is
100,000 bikes

Statement of the Problem

The proposal of Hi-Valu came at a time when


BBC is operating at reduced capacity.
BBC needs to examine the viability and
profitability of this venture.

Objectives

To understand the effects of Hi-Valu proposal


to BBC.
To be able to provide a sound decision on
the Hi-Valu proposal.

Alternative Courses of
Action

Accept Hi-Valu proposal


Decline Hi-Valu proposal

Data Pertinent to Hi-Valu


Proposal

Estimated first-year costs of producing Challenger


bicycles (average unit cost, assuming a constant mix
of models):
Materials
Direct Labor
Overhead (@ 125% of direct labor)

$ 39.80*
19.60
24.50
$ 83.90

*includes items specific models for Hi-Valu, not used in our standard
models
*Accountant says about 40% of total production overhead is variable;
125% of DL$ rate is based on volume of 100,000 per year

Data Pertinent to Hi-Valu


Proposal

One time added cost of approximately $5,000


Unit price and annual volume:
Estimated 25,000 bikes a year
Payment of an average $92.29 per bike for
the first year

Data Pertinent to Hi-Valu


Proposal

Asset related cost (annual variable cost as percent of


dollar value assets)
Pretax cost of funds (to finance receivables or inventories)
11.5%
Record-keeping cost (for receivables or inventories)
Inventory insurance
State property tax on inventory
Inventory-handling labor and equipment
Pilferage, obsolescence, breakage etc.

2.0
0.6
0.7
6.0
2.2
23.0%

Data Pertinent to Hi-Valu


Proposal

Assumptions
for
Challenger-related
added
inventories (average over the year):
Materials: two months supply
Work in process: 1,000 bikes, half completed
(but all materials for them issued)
Finished goods: 500 bikes (awaiting next
carload lot shipment to a Hi-Valu warehouse)
Payment of Hi-Valus payables will be within a
month

Data Pertinent to Hi-Valu


Proposal

Impact on BBCs regular sales:


a. In 1988, BBC sold 98,791 bikes
b. Ms. Leisters best guess is that sales over the
next three years will be about 100,000 bikes a
year if they forego the Hi-Valu deal.
c. If they accept it, they think they will lose about
3,000 units of their regular sales volume a year.
d. These estimates do not include the possibility
that a few of their current dealers might drop
their line if dealers find out that theyre making
bikes for Hi-Valu.

Analysis

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?
5. What is the overall impact on the company in terms of:
a. Profit
b. Return on Sales
c. Return on Assets
d. Return on Equity
6. What are the strategic risks and rewards?
7. What should the company do and why?

Q1

What is the expected profit from the challenger


line?

Q2

What
is
the
expected
impact
cannibalization of existing sales?

of

Q3

What costs will be incurred on a one-time basis


only?
It is arguable that the $5,000 will be differential.
The tasks will still be performed by BBC
employees and it is part of their normal tasks.
The amount is also insignificant.

Q4

What are the additional assets and related


carrying costs?

Q5

What is the overall impact on the company in


terms of:
a. Profit

Q5
What is the overall impact on the company in
terms of:
b. Return on Sales
The effect is increase in ROS of
18%

Q5

Q5
What is the overall impact on the company in
terms of:
c. Return on Assets

Q5
What is the overall impact on the company in
terms of:
d. Return on Equity

Q6
What are the strategic risks and rewards?
RISKS

REWARDS

ACCEPT
Additional competition with
challenger bikes

Opportunity to supply to
department store chain

Loss of opportunity to enter the


mainstream market using BBC
as the brand

Sure order for 3 years (25,000)


despite the poor economy

Current dealers might drop out

Use up excess capacity to


accommodate Hi-Valu

Q6
What are the strategic risks and rewards?
RISKS

REWARDS

DO NOT ACCEPT
Loss of additional profit

Maintain loyal or regular clients

Loss opportunity to enter the


mainstream market

No additional competition

Idle capacity to continue

Use idle capacity to make new


products

Continued decline of sales of


BBC due to poor economy

Q7

What should the company do and why?


Viewing this strictly as a short term decision. BBC should
accept the proposal of Hi-Valu due to additional profit
that it can achieve. Due to the poor economy, it is likely
and more reasonable that the Company should accept
the offer.

However, we should recognize sensitivity as to other


assumptions that might affect this decision in the long
run like if the Hi-Valu volume demand would increase
after the three year contract, additional sales losses in
case current dealers drop the BBC line of bicycles and so
on.

Conclusion

Accepting the proposal of Hi-Valu will be good for the


company as it will provide additional profits for the
company in the next 3 years.
This is a good
opportunity for the Company to finally enter the
mainstream market or department store chains like
Hi-Valu.

Thank You!

You might also like