Baldwin Group 5

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 SolutionsBecause 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 SheetsBase case balance sheet:

Alternative balance sheet:

Assets Liabilities and Owners' EquityCash $342,000.00 Current Liabilities $3,478,000.00Accounts receivable $1,359,000.00 Noncurrent liabilities $1,512,000.00Inventories $2,756,000.00 Total liabilities $4,990,000.00Plant and equipment (net) $3,635,000.00 Owners' equity $3,102,000.00

$8,092,000.00 $8,092,000.00

Assets Liabilities and Owners' EquityCash $342,000.00 Current Liabilities $4,011,402.00Accounts receivable $1,622,769.00 Noncurrent liabilities $1,512,000.00Inventories $3,025,633.00 Total liabilities $5,523,402.00Plant and equipment (net) $3,635,000.00 Owners' equity $3,102,000.00

$8,625,402.00 $8,625,402.00

Income StatementsBase Case: Alternative (Year 1):

Sales revenues Sales revenuesBaldwin name $10,674,900.00Challenger name $2,307,250.00

$11,005,051.00 Total sales revenue $12,982,150.00Cost of sales Cost of sales

Baldwin name $7,899,151.00Challenger name $2,097,500.00

$8,143,454.00 Total cost of sales $9,996,651.00Gross margin $2,861,597.00 Gross margin $2,985,499.00Other expenses $2,354,000.00 Other Expenses $2,354,000.00Other differential costs Other differential costsOne-time added $0.00 One-time added $5,000.00Asset-related costs $0.00 Asset-related costs $95,379.00Income before taxes $507,597.00 Income before taxes $531,120.00Income tax expense $233,945.34 Income tax expense $244,786.81Net income $273,651.66 Net income $286,333.19

Differential RevenuesDifferential 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 RevenuesReject 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 CostsDifferential 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 CostsReject 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 1-41.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: $273,652Accept Proposal: $286,333Difference: $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

CannibalizationCannibalization: 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 $247,138The 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

1988 Base case Year 1 Alternative year 1Profit $255,000 $273,652 $286,333Return on sales 2.35% 2.49% 2.21%Return on assets 3.15% 3.37% 3.32%Return on equity 8.22% 8.82% 9.23%

Base case Years 2 & 3 Alternative Years 2 & 3Profit $273,652 $289,029.00Return on sales 2.49% 2.23%Return on assets 3.37% 3.35%Return on equity 8.82% 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 ProposalRisks

• 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 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

• 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

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!