Baldwin Bicycle Company

Analysis of Case 26-5

Bryan Jerrett Louise Krogh Sherrie Reynolds Nov. 9, 2005

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

Assets Cash Accounts receivable Inventories Plant and equipment (net)

Alternative balance sheet:

$342,000.00 $1,622,769.00 $3,025,633.00 $3,635,000.00 $8,625,402.00

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

$11,005,051.00 Cost of sales

Gross margin Other expenses Other differential costs One-time added Asset-related costs Income before taxes Income tax expense Net income

$8,143,454.00 $2,861,597.00 $2,354,000.00 $0.00 $0.00 $507,597.00 $233,945.34 $273,651.66

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

Accept Proposal Projected sales:

97,000 Baldwin 25,000 Challenger

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

Accept Proposal Unit cost:

$81.43 Baldwin $83.90 Challenger

Cost of sales:
$8,143,454

Cost of sales:
$9,996,651

Income tax expense:

$233,945

Asset-related costs:
$95,379

Income tax expense:

$244,787

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?

Differential Profit (Year 1)

Revenue Total Costs = Profit Reject Proposal: $273,652 Accept Proposal: $286,333 Difference: $12,681 By accepting the proposal, BBC stands to make $12,681 more than by maintaining the status-quo

Differential Profit (Years 2 & 3)

Three year contract between BBC and HVS
One-time costs of $5000 are incurred by BBC in year one

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

Assets and Carrying Costs

The additional assets are the increases in inventories and receivables associated with the addition of the production of the Challenger line The increase in inventory is $269,633 and the increase in receivables is $247,138 The added carrying costs are 23% of added inventories and 13.5% of added receivables which amount to $62,015 for inventories and $33,364 for receivables

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

What are the strategic risks and rewards?

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

Accept Proposal - Risks

Current dealers may BBC may find itself with an abundance of drop Baldwin line Challenger-specific Current dealers may inventory request a similar product (Challenger) Extra costs may result in having to use Loss of street cred cheaper materials Putting faith in a new product

Accept Proposal - Rewards

With Challenger line, If Baldwin name is not on the Challenger BBC will be bike, BBC's producing at a higher reputation may not be capacity damaged Greater penetration of Strong Challenger the market through sales may balance new market segments weak Baldwin sales

Question 7

What should the company do and why?

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!