Celina Lin Managerial Accounting Prof.

Sarath Baldwin Bicycles Case

According to information given under Exhibit 1, Ms. Leister notes that the bicycle boom had flattened out and in addition, a poor economy had contributed to Baldwins falling sales volume over the past two years. The Baldwin plant is operating at 75% of one-shift capacity, so there is spare capacity available for Hi-Valus order of purchases. On the Hi-Valu deal, Baldwins contribution margin is $577,250.00 for the order of 25,000 bikes ($92.29/bike * 25,000 bikes - $69.20/bike * 25,000 bikes, or $23.09 unit CM 25,000 units = $577,250; Unit price and volume from Exhibit 2, item 3 and $69.20 was calculated from Exhibit 2, item 1: Materials- 39.80 + Labor- 19.60 + OH- 24.50 *.4 (because 40% of OH is variable). This contribution margin is lower than it would be with Baldwins normal sales because HiValu wanted to sell its Challenger bikes at lower prices than the name-brand bikes it carried but still earn the same dollar gross margin on each bike sold. Therefore Hi-Valu will purchase bikes from Baldwin at lower prices than the wholesale prices of comparable bikes sold by Baldwin. The Hi-Valu order should be classified as a special order because Baldwin would need to raise the level it is currently operating at and sell at a lower price than normal. Hi-Valus proposal is noted to have features that make it quite different from Baldwins normal way of doing business, for example the paying process and title requirements are different. Moreover, the Challenger bike is set to be somewhat different in appearance from Baldwins other bikes. When deciding whether to accept this special order, Baldwin should ask whether there are any additional costs specific to this order that must be incurred. Baldwin should also ask whether Hi-Valus order would affect its other sales. In this case, the additional costs include the one time fixed costs of $5,000 (Exhibit 2, item 2) and recurring fixed costs of the additional materials of $39.80 per Challenger bike produced (Exhibit 2, item 1). The acceptance of the Hi-Val order will affect other sales because Ms. Leister thinks Baldwin will lose about 3,000 units of the regular sales volume a year, since Baldwins retail distribution is quite strong in Hi-Valus market regions; Baldwin will lose production of other bikes. There is also the possibility that a few of Baldwins current dealers might drop the Baldwin line if they find out that Baldwin is making bikes for Hi-Valu (Exhibit 2, item 6). It will typically take two months to sell a bicycle Because it will typically take two months to sell a bicycle since Mr. Knott estimates that a bike would remain in a Hi-Valu regional warehouse for two months, this represents a higher opportunity cost of capital as a result of more money being locked in. Thus, there is the pre-tax cost of funds for every dollar they lock up or face and hold for some length of time. Questions that must be asked regarding a long-term special-order arrangement concerning the HiValu deal would include the question of what would happen if the person taking the order decides not to work with you anymore. This could occur if the market goes weak and he or she did not want your product anymore. As for this Hi-Valu deal, two things that must be accounted for are the time value of money if you are locked into the deal. The discounted cash flow analysis to calculate the value of this long-term contract suggests that this is not a profit-increasing deal for Baldwin. Thus, Baldwin would not proceed with this deal for the long-term because the profit does not increase. The new "discount bike" would compete directly with Baldwin's existing lines while generating less profit for the company since the bikes themselves will only differ in cosmetic ways. By selling the bikes to the discount department store chain, Baldwin is not only creating a direct competitor to its regular customers, but also giving that competitor a better price than its regular customers. Possible long-term results of Baldwin entering the discount segment of the market include Baldwin's dealers potentially dropping Baldwin bikes and adopting a competitor's line. This would drive Baldwin further into the discount segment of the market.

First-Year Economic Analysis for Baldwin How much does the Hi Val order contribute? Average Selling Price (Exhibit 2, item 3): Materials (Exhibit 2, item 1) Labor Variable OH ($24.50 * 40% -footnote 3) Incremental Relevant Cost of Each Challenger Pre-Tax Unit Contribution Margin $39.80 19.60 9.80

$92.29

69.20 $23.09

How much capital gets tied up? Assumption 1 Expected production 25,000/12 = 2,084/month or 4,167 for two months (Exhibit 2, item 3) Inventory assumptions - two months raw materials (p.1) - 1000 bikes WIP raw materials added other factors 50% (Exhibit 2, item 5) - Finished goods 500 bicycles (Exhibit 2, item 5) Receivables Assumption -30 days to collect (p.1) Payables Assumption -30 days to pay (p.1) Materials (2 months)
4,167 bikes (calculated above in expected production) *$39.80 Materials per unit as shown in Exhibit 2, item 1

$165,847

Work in process Materials per unit (100% complete) Labor per unit (50% complete =19.6/2) VOH per unit (50% complete =9.8/2) WIP incremental costs per unit Total WIP Investment Finished Inventory in our factory

$39.80 9.80 4.90 $54.50 * 1000 54,500 34,600 $254,947 288,356 $543,303

500 bikes * $69.20 (incremental rel. cost/Challenger as calc above)

Inventories at Baldwin locations Finished Inventory in HV warehouse (2 months)

4,167 bikes (expected production) * $69.20 (incremental rel. cost)

Total inventory investment

Impact on Receivables and Payables Impact on receivables (30 days of sales): 2,084 bikes/month (expected production) * $92.29 (selling price) Impact on short-term payables (30 days of bike sales): Materials vendors 2,084 bikes * $39.80 Wages payables 2,084 bikes * $19.60 A/P for variable OH 2,084 bikes * $9.80 Total short-term payables increase Cost of Capital Tied up in production: Summary Net working capital increase: Inventories A/R Less: short-term payables Incremental working capital investment Tax rate (from financial/income statement) 218/473 = 46%

$192,332 $82,943 40,846 20,423 $144,212

$543,303 $192,332 (144,212) $591,423

After-Tax cost of capital 18% (Exhibit 2, item 4) *.54 (46% taxed, so 54% not taxed)= 9.72% Estimated Opportunity cost of Production 600,000 ($591,423 rounded up) *10% = $60,000 Other Asset-Related Costs Two components to computation: 1. Incremental outlay cost: Inventories: Record keeping Insurance Property tax Pilferage, obsolescence Inventory handling Incremental inventory-related costs (pre-tax) At Hi-Valu 1.00% 0.30% 0.70% 0.50% 2.50% At Baldwin 1.00% 0.30% 0.70% 0.50% 3.00% 5.50%

For receivables plus payables increase: record keeping, pre-tax 1%; 2. Opportunity cost of capital 10%.