IB 505
Final Case
Fall 2010
THIS CASE IS TO BE COMPLETED IN A PROFESSIONAL MANNER. THE FOLLOWING GUIDELINES WILL APPLY:
- All materials should be typed (or electronic file suitable for email).
- Clarity of expression and logical support for answers will be an important consideration in evaluating the papers.
- Computations should be shown in a neat and orderly fashion. Separate schedules may be used to summarize computations, but they must be clearly referenced to the text in such a way as to improve readability and understanding.
- STUDENTS ARE TO COMPLETE THIS ASSIGNMENT INDEPENDENTLY!
There should not be communication among other members of the class, or anyone else. Contact the instructor for clarification of the assignment or any related questions.
- The completed case will be due NO LATER than 1:00 p.m. on December 10, 2010. Either hardcopy or email submissions will be accepted.
ROLLING ROAD BICYCLE COMPANY
In May 1983, Suzanne Leister, marketing vice president of ROLLING ROAD BICYCLE COMPANY, was mulling over the discussion she had the previous day with Sawyer Profit, a buyer from Dandy Discount Mart Stores, Inc. Dandy Discount Mart operated a chain of discount department stores throughout the United States. Dandy Discount Mart’s sales volume had grown to the extent that it was beginning to add “house-brand” (also called “private-label”) merchandise to the product lines of several of its departments. Mr. Profit, Dandy Discount Mart’s buyer for sporting goods, had approached Ms. Leister about the possibility of Rolling Road producing bicycles for Dandy Discount Mart. The bicycles would bear the name “Speeding Bullet,” which Dandy Discount Mart planned to use for all of its house-brand cycles.
Rolling Road had been making bicycles for almost 40 years. In 1983, the company’s line included 10 models, ranging from a small beginner’s model with training wheels to a deluxe 12-speed adult’s model. Sales were currently at an annual rate of about $10 million. The company’s 1982 financial statements appear in Exhibit 1. Most of Rolling Road’s sales were through independently owned retailers (toy stores, hardware stores, sporting goods stores) and bicycle shops. Rolling Road had never before distributed its products through department store chains of any type. Ms. Leister felt that Rolling Road bicycles had the image of being above average in quality and price, but not a “top-of-the-line” product.
Dandy Discount Mart’s proposal to Rolling Road had features that made it quite different from Rolling Road ’s normal way of doing business. First, it was very important to Dandy Discount Mart to have ready access to a large inventory of bicycles, because Dandy Discount Mart had great difficulty in predicting bicycle sales, both by store and by month. Dandy Discount Mart wanted to carry these inventories in its regional warehouses, but did not want title on a bicycle to pass from Rolling Road to Dandy Discount Mart until the bicycle was shipped from one of its regional warehouses to a specific Dandy Discount Mart store. At that point, Dandy Discount Mart would regard the bicycle as having been purchased from Rolling Road , and would pay for it within 30 days. However, Dandy Discount Mart would agree to take title to any bicycle that had been in one of its warehouses for four months, again paying for it within 30 days. Mr. Profit estimated that on average, a bike would remain in a Dandy Discount Mart warehouse for 2.5 months.
Second, Dandy Discount Mart wanted to sell its Speeding Bulletbicycles at lower prices than the name-brand bicycles it carried, and yet still earn approximately the same dollar gross margin on each bicycle sold – the rationale being that Speeding Bullet bike sales would take away from the sales of the name-brand bikes. Thus, Dandy Discount Mart wanted to purchase bikes from Rolling Road at lower prices than the wholesale prices of comparable bikes sold through Rolling Road ’s usual channels.
Finally, Dandy Discount Mart wanted the Speeding Bullet bike to be somewhat different in appearance from Rolling Road ’s other bikes. While the frame and mechanical components could be the same as used on current Rolling Road models, the fenders, seats, and handlebars would have to have the name Speeding Bullet molded into their sidewalls. Also, the bicycles would have to be packed in boxes printed with Dandy Discount Mart and Speeding Bullet names. These requirements were expected by Ms. Leister to increase Rolling Road ’s purchasing, inventorying, and production costs over and above the added costs that would be incurred for a comparable increase in volume for Rolling Road ’s regular products.
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On the positive side, Ms. Leister was acutely aware that the bicycle boom had flattened out, and this plus a poor economy had caused Rolling Road ’s sales volume to fall the past two years.* As a result, Rolling Road currently was operating its plant at about 75 percent of one-shift capacity. Thus, the added volume from Dandy Discount Mart’s purchases could possibly be very attractive. If agreement could be reached on prices, Dandy Discount Mart would sign a contract guaranteeing to Rolling Road that Dandy Discount Mart would buy its house-brand bicycles only from Rolling Road for a three-year period. The contract would then be automatically extended on a year-to-year basis, unless one party gave the other at least three-months notice that it did not wish to extend the contract.
Suzanne Leister realized she needed to do some preliminary financial analysis of this proposal before having any further discussions with Sawyer Profit. She had written on a pad the information she had gathered to use in her initial analysis; this information is shown in Exhibit 2.
*Note: The American bicycle industry had become very volatile in recent years. From 1967 through 1970 sales averaged about 7 million units a year. By 1973 the total was up to a record 15 million units. By 1975 volume was back down to 7.5 million units. By 1982 volume was back up to 10 million units, still well below the peak years.
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EXHIBIT 1Financial Statements (thousands of dollars)
Rolling Road COMPANY
Balance Sheet
As of December 31, 1982
Cash / 342 / Accounts payable / 512
Accounts receivable / 1,359 / Accrued expenses / 340
Inventories / 2,756 / Short-term bank loans / 2,626
Plant & Equipment (net) / 3,635 / Long-term note payable / 1,512
Total liabilities / 4,990
Owners’ equity / 3,102
8,092 / 8,092
Rolling Road COMPANY
Income Statement
For the Year Ended, December 31, 1982
Sales revenues / 10,872
Cost of goods sold / 8,043
Gross margin / 2,829
Selling & admin exp.* / 2,354
Income before taxes / 475
Income tax expense / 190
Net income / 285
NOTE: *Total fixed selling & administrative expenses were $2 million. All variable selling and administrative costs are related to shipping. No significant change in behavior patterns of variable S&A costs is anticipated for future years, but fixed S&A costs would increase by $45,000 resulting from the hiring of a new traffic manager to handle Speeding Bullet deliveries.
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EXHIBIT 2
1. Estimated first-year costs of producing Speeding Bullet bicycles
(average unit costs, assuming a constant mix of models)
Materials / 39.80 *Labor (assume variable) / 19.60
Manufacturing overhead / 20.00 **
79.40
NOTES: * Does not include materials specific to models for Dandy Discount Mart, production manager estimates these additional materials would be $3.25 per unit.
** The accountant (such a sweet guy) provided this manufacturing overhead rate, which was the same one used last year (based on a “normal volume” of 100,000 units). His estimate is that 60 percent of total manufacturing overhead cost is fixed. He believes that manufacturing overhead cost behavior patterns will remain the same as in 1982 (per unit variable manufacturing overhead and total fixed manufacturing overhead will not change).
2. Unit price and annual volume:
Dandy Discount Mart estimates it will need 25,000 bikes a year and proposes to pay us (based on the assumed mix of models) an average of $95.00 per bike for the first year. The contract would contain an inflation escalation clause such that price will increase in proportion to inflation-caused increases in costs shown in item 1, above; thus, the $95.00 and the cost figures are in effect, “constant dollar” amounts. Profit intimated that there was very little, if any, negotiating leeway in the proposed price. However, if demand for the Speeding Bullet exceeds expectations, Sawyer Profit agrees to take up to an additional 5,000 units and will pay Rolling Road’s average selling price per bike in 1982 for these “bonus units.” Rolling Road’s marketing department has assigned a probability of 15% that these additional sales will occur. Ms. Leister is aware that Dandy Discount Mart normally takes a very aggressive position on terms with its suppliers.
3. After-tax asset-related costs:
The firm estimates that incremental out-of-pocket interest costs related to an increased investment in receivables or inventories will be 10% (based on the average asset values).
In addition, the accountant normally allocates some fixed administrative record keeping costs as an asset-related cost for decision making purposes. This would amount to 1.0% of the dollar value of average receivables and inventories.
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EXHIBIT 2
(Continued)
4. Assumptions for added inventories and receivables related to Speeding Bullet(average over the year):
Materials (normal & additional materials): Two months supply
Work in process: 750 bikes, 50% completed (but all materials for them issued)
Finished goods: 500 bikes (awaiting next shipment to Dandy Discount Mart warehouses).
Rolling Road will pay for shipping items to Dandy Discount Mart’s warehouses, and the variable shipping costs behavior pattern is assumed to be the same as 1982.
5. Impact on our regular sales (analysis from Leister):
Some customers comparison shop for bikes, and many of them are likely to recognize a Speeding Bullet bike as a good value when compared with a similar bike (either ours or a competitor’s) at a higher price in a non-chain toy or bicycle store. In 1982, we sold 98,791 bikes. My best guess is that our sales over the next three years will be about 100,000 bikes a year if we forego the Dandy Discount Mart deal. If we accept it, I think we’ll lose about 10,000 units of our regular sales volume a year, since our retail distribution is quite strong in Dandy Discount Mart’s market regions (short-term inventory reductions of regular bikes would probably be only 25% of lost sales due to our seasonal markets). This estimate does not include the possibility that a few of our current dealers might drop our line completely if they find out we’re making bikes for Dandy Discount Mart.
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REQUIRED: Answer the following questions (showing all computations in an orderly fashion and presenting conclusions in a logical and effective manner):
- In the first 12 operating months of the contract, what would be the TOTAL INCREMENTAL impact on net income of adding the Speeding Bullet line? Be sure to consider ALL relevant items for which you have information! This requirement does not mean specifically calendar 1983 – do not try to “fine-tune” this answer to a certain number of months in 1983! Simply calculate the impact for the first full operating year! For this initial requirement, you should stay within the assumptions given in the case.
YOU SHOULD NOTPRESENT A TOTAL INCOME STATEMENT (combining the Speeding Bullet line with our current lines)!! ONLY PRESENT THE INCREMENTAL IMPACT OF THE SPEEDING BULLET!!!!!!
Hint: You may find it easier to initially compute some of the items regarding the Speeding Bullet on a per-unit basis and then move to totals where that approach is simpler.
2. Are there aspects of Dandy Discount Mart’s offer which cause you particular concern? List and explain (be as specific as possible). What additional information would you like to have before making this decision?
3. What are the strategic RISKS and REWARDS of adding the Speeding Bullet line? Be as specific as possible!
4. Should Rolling Road Company accept the Speeding Bullet business assuming Dandy Discount Mart is unwilling to make changes in their conditions? Why? Be specific - I want a YES or NO answer with a CAREFUL EXPLANATION OF YOUR REASONING!
5. Independent of your answer to Question 4, what other strategic issues face ROLLING ROAD BICYCLE COMPANY? What alternatives might they consider to the Dandy Discount Mart proposal?
If you anticipate significant changes in Rolling Road ’s operations, how might some of the strategic management and accounting techniques discussed during the latter part of the class be useful?