Miller Orchard Case -
Paul and John Miller have just been presented with an offer from their uncle. Uncle Joe can no longer manage his orange orchard, which produces orange juice that is bought by local restaurants and diners to serve their customers; he has offered to turn it over to his nephews to manage as they like if they can provide him a small annual return (10% of sales revenue) to supplement his retirement. Paul and John have grown up with the orchard and worked there all through their childhood, so they know the business well and love the work. They are very excited by this prospect. Miller Orchard typically yields about 1,200,000 pounds of oranges a season. Oranges are cultivated and harvested when ripe; then the juice is extracted. The remaining pulp and rind are recycled back onto the fields whenever possible or disposed of. Paul and John know that the amount of oranges available for harvest and the amount of juice generated from the oranges is variable, however, dependent each year on a number of climatic and growing factors such as temperature, length of growing season, and fertilizers used. Every year so far, Miller Orchard has sold all the orange juice that it has produced. The current selling price is $5 per bottle. Uncle Joe presents the brothers with an Income Statement that he has had prepared for last year (see Exhibit 1). He provides the following additional information:
Bottling
Requires 12 pounds of oranges for each bottle of juice. In the bottling process, the juice is put into bottles, with both bottle caps and labels added during this process. The materials cost associated with the bottles, caps, and labels averages $1.25/bottle.
Direct labor
Harvest labor is paid an average of $9.00/hour. An average of 300 pounds of oranges can be harvested each hour. Extraction labor is paid an average of $11.00/hour. The extraction process can be completed for 600 pounds of oranges each hour.
Overhead expenses
Supervisor salary -- supervises the production from the cultivation and harvest through the bottling processes. His salary and benefits total $80,000 annually. Sales salary – a sales person receives salary and benefits of $60,000, plus $.50/bottle for each bottle sold. Packing/shipping labor – workers pack 100 bottles per hour for shipment and are paid an average of $10.00/hour. Waste treatment – After crushing, the pulp, seeds, and rind that are left over must be disposed of. One-half of the waste can be recycled back onto the fields as a compost material; the other half must be disposed of at a landfill with a dumping cost of $2,000.
Paul and John figure that if they can each earn salary and benefits of about $90,000 to start, they can support their families and start to develop a promising business. They plan to work the orchard themselves, eliminating the cost of the supervisor and sales manager (although they would probably need to pay distributors the $.50 for each bottle sold). They anticipate that the remaining costs will be unchanged.
Required:
1. Based on Uncle Joe’s results from last year, determine which costs are variable and which are fixed, and then develop a contribution margin analysis for the venture. What is the contribution per bottle of juice? What is the contribution margin with the changes that Paul and John want to make, assuming that production and sales remain the same? What is the number of bottles of orange juice that they would need to sell to break even?
2. If Paul and John find that they need to increase their own salary/benefit packages to $110,000, how many bottles would they need to sell? Is this feasible?
3. Should Paul and John investigate further before starting into this venture? What other factors might impact the success of their business? Should they accept?