Case Analysis: Baldwin Bicycle Company (BBC)

By Jie Lan Marion Paul Phillip

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Table of Contents
Part 1. Introduction Part 2. Quantitative Analysis (Q. 1-5) Part 3. Qualitative Analysis (Q. 6) Part 4. Decision Time (Q. 7)

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Introduction

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BBC Overview
Manufactures and sells bikes to independent bike stores Above average in quality and price $10M annual sales. Sales declined in past 2 years Factory operating at reduced capacity

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Hi-Valu Proposal
Sell bikes to a department store chain Use Challenger Label. Annual Sales of 25,000. Extra inventory costs Sell at lower than usual wholesale prices Small one time design costs 3 year deal, 6 month notice to opt out. We have unused factory capacity
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Costs
$83.90 to manufacture. $92.29 selling price
Split between materials, labor, direct overhead and indirect overhead.

Asset Related Costs

Cost of funds, Record keeping, inventory insurance, tax on inventory, inventory handling, pilferage and damage
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Costs (continued)
Inventory
Raw materials Work in progress Finished goods in house Finished goods outside the factory.

Accounts Payable

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Risks
Loose 3000 sales of regular line of bikes Existing independent stores may drop our products

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Alternatives
Refuse proposal and continue business as usual Accept the Hi-valu proposal. Negotiate the Hi-Valu proposal Approach another department store for a better deal. Business as usual but lower our prices
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Question 1.
What is the expected added profit from the Challenger line?

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Q.1 What is the expected added profit from the Challenger line?
Added profit, does not include cannibalization Contribution = added sales added cost Added cost: variable cost fixed cost one time cost (R&D) asset related cost (expenses)

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Q.1 What is the expected added profit from the Challenger line?
added cost (per unit) = variable cost (per unit)
= materials + direct labor +variable part of overhead

= $39.8 + = $69.2

$19.6

($24.5 40%)

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Q.1 What is the expected added profit from the Challenger line?
Estimated sale of Challenger 25,000 per year Average price $92.29 per bike
Total Contribution = unit contribution #of units sold

($92.29 - $69.2) 25,000 = $577,250

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Question 2.
What is the expected impact of cannibalization of existing sales?

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Q.2 What is the expected impact of cannibalization of existing sales?

Challenger has competitive advantage loss of 3000 sale per year Current dealers drop line, loss of more sales Impact of cannibalization = loss of profit margin

=decrease in sales revenue decrease in cost of sales

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Q.2 What is the expected impact of cannibalization of existing sales?

Decrease in sales revenue of regular products
= average unit price decrease in number of units sold

($10,872,000 / 98,791) 3,000 = $330,151.53

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Q.2 What is the expected impact of cannibalization of existing sales?

Only variable cost sensitive to change in volume Using Challengers unit fixed cost as an estimate Decrease in cost of sales = decrease in variable cost = unit variable cost decrease in volume = (total unit cost per unit fixed cost) 3000 = ($8,045,000 / 98,791 - $24.5 60%) 3,000 = $200,203.63
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Q.2 What is the expected impact of cannibalization of existing sales?

Impact of cannibalization =decrease in sales revenue decrease in cost of sales = $330,151.53 - $200,203.63 = $129,947.90 Based on assumption that fixed cost per unit doesn't change from regular products to Challenger line Based on estimated loss of sales of 3,000 units Possible that sales decrease exceeds 3,000 if any current dealer drops line, impact could be greater
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Question 3.
What costs will be incurred on a one-time basis only?

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Q.3 What costs will be incurred on a one-time basis only?

Preparing drawings a/o arranging parts and materials different than standard models $5,000 Not production cost Treated as R&D cost

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Q4: what are the additional assets and related carrying cost? increase in inventories Baldwins
warehouse

increase in inventories Hi-Valus warehouse

Increase in receivables

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The Calculation of the Additional Assets

categories items
materials raise in inventory --- Baldwin's warehouse work in process finished goods raise in inventory --- Hi-Valu's warehouse

amount
165,833.33 61,850.00 41,950.00

calculation
39.8 * 25000 / 12 * 2 [39.8+(19.6+24.5)/2] * 1000 83.9 * 500

average 2 months waiting time in warehouse

349,583.33

83.9 * 25,000/12*2

raise in receivable accounts

1month collection period

192,270.83

92.29 * 25000 / 12

Additional Assets :

165,833.33 + 61,850 + 41,950 + 349,583.33 + 192,270.83= 811,487.49

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Asset-related costs

Pretax Cost of funds
(Inventories and receivables )

11.5%

Recordkeeping Costs (Inventories and receivables ) Inventory Insurance State Property Tax on Inventory Inventory-handling Labor and Equipment Pilferage, Obsolescence, Damage, etc.
Total

2.0% 0.6% 0.7% 6.0% 2.2%

23%

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Assets-related Costs

categories

items

amount

calculation

inventory-related costs --- Baldwin's warehouse

23% of dollar value of inventories

62,015.67

(165,833.33 + 61,850 + 41,950) * 23%

inventory-related costs --- Hi-Valu's warehouse

17% of dollar value of inventories

59,429.17

349,583.33 * 17%

receivable-ralated costs

13.5% of dollar value of receivable account

25,956.56

192,270.83 * 13.5%

related carrying costs :

62,015.67 + 59,429.17 +25,956.56 = 147,401.40

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Q5: 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?

The most direct way to solve this problem is to assume accepting the contract and to calculate the each

measure after that.

For the lack of information, we need make many assumptions and estimations in process.

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To calculate the Net Income

Measures Revenue Cost of sales Gross Margin Expenses 1988 (volume=98,791) 10,872,000.00 8,045,000.00 2,827,000.00 (3) after adopting the contract (first year) (1) (2) 12,982,149.54 9,673,250.73 3,308,898.81 152,401.4 Assumptions

Other Expenses
Income before Taxes

2,354,000.00
473,000.00

2,354,000.00
802,497.41

There is not obvious change in other expenses

Income Tax Ratio

46.00%

46.00%

The increase in sales is not sufficient to use higher Tax Ratio

Income Tax Expense Net Income

218,000.00 255,000.00

369,148.81 433,348.6

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(1) Revenue after adopting the contract

Calculatio n

regular production

Calculation

Challenger

10,674,899.54

10,872,000 /98,791 * 97,000

2,307,250

92.29 * 25000

Total Revenue :

12,982,149.54

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(2) Total costs after adopting the contract

regular production Calculation Challenger Calculation

7,943,250.73

8,045,000 / 98,791 * 97,000 + 44,100

1,730,000

69.2*25000

Total Cost:

963,250.73

*** $44,100 ---- The fixed costs of 3000 units

44,100 = 19.6 *125%* 60% * 3000

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To calculate the Net Income

Measures Revenue Cost of sales Gross Margin Expenses Other Expenses Income before Taxes Income Tax Ratio Income Tax Expense Net Income 2,354,000.00 473,000.00 46.00% 218,000.00 255,000.00 1988 (volume=98,791) 10,872,000.00 8,045,000.00 2,827,000.00 (3) after adopting the contract (first year) (1) (2) 12,982,149.54 9,673,250.73 3,308,898.81 152,401.4 2,354,000.00 802,497.41 46.00% 369,148.81 433,348.6 The increase in sales is not sufficient to use higher Tax Ratio There is not obvious change in other expenses Assumptions

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(3) Expense
Research and Development Expense:
one-time added costs of preparing drawings and/or arranging sources for fenders, seats, handlebars, tires, and shipping boxes that differ from those used in our standard modes; approximately $5,000

Expenses caused by the increase of assets:

$147,401.4

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To calculate the Net Income

Measures Revenue Cost of sales Gross Margin Expenses Other Expenses Income before Taxes Income Tax Ratio Income Tax Expense Net Income 2,354,000.00 473,000.00 46.00% 218,000.00 255,000.00 1988 (volume=98,791) 10,872,000.00 8,045,000.00 2,827,000.00 (3) after adopting the contract (first year) (1) (2) 12,982,149.54 9,673,250.73 3,308,898.81 152,401.4 2,354,000.00 802,497.41 46.00% 369,148.81 433,348.6 The increase in sales is not sufficient to use higher Tax Ratio There is not obvious change in other expenses Assumptions

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The impact to each measure

Measures Net Income Return on Sales Assets Return on Assets = Net Income/ Assets Equity Return on Equity = Net Income/ Equity 1988 after adopting the (volume=98,791) contract (first year) 255,000.00 2.35% 8,092,000.00 3.15% (4) Impact

433,348.60 increase 3.34% increase 9,336,836.09 increase 4.64% increase

3,102 8.22% (5)

3,535,348.6 increase 12.26% increase

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(4) The change of Asset

Extreme Conditions 9,336,836.09 = 8,092,000 + 811,487.49 + 433,384.6
BALDWIN BICYCLE COMPANY
Balance Sheet As of December 31,1988
(In thousand)

Assets Case Accounts Receivable Inventories Pant and Equipment (net) $342 1,359 2,756 3,635 $8,092

Liabilities and owners equity Current liabilities Noncurrent liabilities Total liabilities Owners equity $3,478 1,512 4,990 3,102 $8,092

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The impact to each measure

Measures Net Income Return on Sales Assets Return on Assets = Net Income/ Assets Equity Return on Equity = Net Income/ Equity 1988 after adopting the (volume=98,791) contract (first year) 255,000.00 2.35% 8,092,000.00 3.15% (4) Impact

433,348.60 increase 3.34% increase 9,336,836.09 increase 4.64% increase

3,102 8.22% (5)

3,535,348.6 increase 12.26% increase

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Question 6
Identify those consequences that cannot be expressed in quantitative terms and evaluate them against each other and against the measured consequences. Answers question #6: What are the strategic risks and rewards?

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Risks
Cannibalization Damage to Brand Image Problems with Small Dealers Impact to Inventory Buyer Monopoly Decrease in Demand

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Reward$
Profit$$$$$ New Market$ Investment Opportunity New Technology Initial Public Offering (IPO) Plant Utilization Supplying Other Department Stores Capture Market Trend
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Decision Time

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Decision - Next Steps

Market Analysis
Contract Negotiations

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Decision Market Analysis

Determine scope and diversity of new market Aid in negotiating contract Reveal new target segments Identify other clients for new line
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Decision Contract Negotiations

Negotiate Price

Profit Margin Calculation Profit Margin (New) Profit Margin (Old) Difference Unit profit / Unit cost = $8.39 / $83.90 = 10% Unit profit / Unit cost = $28.62 / $81.43 = 26.6% (26.6 10) / 26.6 = 63.8% = 64% Decrease

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Decision Contract Negotiations

Negotiate Minimum Volume
Break Even Calculation Total Fixed Cost (TFC) $14.70 x 25000 = $367,500 + 5000/3 = $369,166.67 $92.29 $69.20 UR UVC = $92.29 $69.20 = $23.09 $23.09 / $92.29 = 25% XB = TFC / Contribution = 15,988 units
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$5000 one time fixed cost over the first 3 years of the contract

Unit Revenue (UR) Unit Variable Cost (UVC) Unit Contribution Contribution % Break Even Point

Decision Contract Negotiations

Negotiate Brand co-ownership

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Decision Conclusion
Reasonable Quantitative Risk / Reward Ratio Reasonable Qualitative Risk / Reward Ratio
Accept the deal

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Questions ?

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Thank You!

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