Published on August 4, 2012
Baldwin Bicycle Company: Baldwin Bicycle Company Analysis of Case 26-5 Bryan Jerrett Louise Krogh Sherrie Reynolds Nov. 9, 2005 Overview: Overview Synopsis of case Definition of Problem Possible Alternative Solutions Evaluation of Quantitative Factors Evaluation of Qualitative Factors Recommendations Synopsis of Case: 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: 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: 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: 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: Balance Sheets Base case balance sheet: Alternative balance sheet: Income Statements: Income Statements Differential Revenues: 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: Differential Revenues Reject Proposal Projected sales: 100,000 bikes Unit price: $110.05 Sales revenue: $11,005,051 Accept Proposal Projected sales: 97,000 Baldwin 25,000 Challenger Unit price: $110.05 $92.29 Sales revenue: $12,982,150 Differential Costs: 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: Differential Costs Reject Proposal Unit cost: $81.43 Cost of sales: $8,143,454 Income tax expense: $233,945 Accept Proposal Unit cost: $81.43 Baldwin $83.90 Challenger Cost of sales: $9,996,651 Asset-related costs: $95,379 Income tax expense: $244,787 Questions 1-4: Questions 1-4 What is the expected added profit from the Challenger line? What is the expected impact of cannibalization of existing sales? What costs will be incurred on a one-time basis only? What are the additional assets and related carrying costs? Differential Profit (Year 1): 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): 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 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: 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: 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: 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: Ratio Analysis Qualitative Factors: 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: 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: Question 6 What are the strategic risks and rewards? Reject Proposal: 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: Accept Proposal - Risks Current dealers may drop Baldwin line Current dealers may request a similar product (Challenger) Loss of “street cred” Putting faith in a new product BBC may find itself with an abundance of Challenger-specific inventory Extra costs may result in having to use cheaper materials Accept Proposal - Rewards: Accept Proposal - Rewards With Challenger line, BBC will be producing at a higher capacity Greater penetration of the market through new market segments If Baldwin name is not on the Challenger bike, BBC's reputation may not be damaged Strong Challenger sales may balance weak Baldwin sales Question 7: Question 7 What should the company do and why? Recommendations: 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: 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!: Thank You!