Case Study: Baby Center Ltd.
Baby Center Ltd. makes portable high chairs. The high chair is generally marketed through exclusive retailers located in upscale shopping malls. In late 2017, Diana Suarez, the president of the company, was considering an alternative marketing plan for 2018 that was presented to her by Bill Duffy, the marketing manager. Based on sales from January through October 2017, Diana expected that 2018 sales would amount to 30,000 units. Bill's alternative marketing plan is presented below:
2018 Marketing Plan: "At the present time, we sell the product to retailers for $58.00 per high chair. Retailers generally charge the consumers between $64.99 and $69.99. If we cut our selling price to retailers to $56.00, I expect that the product will do much better. Their increased markup will give them the incentive to display our product more prominently and to promote it more vigorously to customers. We should support this strategy by supplying more promotional materials to retailers, which I expect would be an increase of $5,000 in Advertising and Promotion costs. Based on the price cut and the increase in advertising and promotion, I expect that we will be able to boost our sales volume by 25 percent to 37,500 units in 2018."
Diana received cost data from the company's CFO, Don Capp. Don expects that the cost data below are also reliable estimates for 2018 for a production volume up to 40,000 units. Beyond 40,000 units, the company would have to rent additional machines (with a capacity of 10,000 units each), which would increase fixed manufacturing overhead costs by $8,000 per machine.
2017 Cost Data
Manufacturing Costs for high chairs (based on production volume of 30,000 units):
Direct Materials $22 per unit
Direct Labor $16 per hour (each worker can make 2 units in 1 hour)
Packaging $3 per unit
Variable Manufacturing Overhead $2.50 per unit
Fixed Manufacturing Overhead $140,000
Selling and Administrative Costs for high chairs (based on sales volume of 30,000 units):
Sales Commissions $5.80 per unit
Shipping Costs $4.00 per unit
Advertising and Promotion (fixed) $15,000
Fixed Selling and Admin Expenses $12,000
Part 1: Using the information on page 1, answer the following questions. Include all costs (manufacturing costs and selling and administrative costs) in your calculations.
1. Prepare a CVP Income Statement for 2017 using the current production and sales volume (30,000 high chairs) and the current cost data, assuming no changes to selling price or costs.
2. Using the 2017 cost data, determine the 2017 break-even point in number of high chairs for the company, assuming no changes to selling price or costs. For full credit, please show the elements of your computations. Round to the nearest next whole unit.
3. Assuming the selling price and cost changes in the Marketing Plan are adopted, prepare a CVP Income Statement for 2018, assuming sales and production increase by 25% as outlined in the Marketing Plan.
4. Assuming the selling price and cost changes in the Marketing Plan are adopted, determine the break-even point in number of high chairs for the company in 2018. For full credit, please show the elements of your computations. Round to the nearest next whole unit.
5. Assuming the selling price and cost changes in the Marketing Plan are adopted, determine the number of high chairs the company would need to sell in 2018 in order to earn $250,000 in profit. For full credit, please show the elements of your computations. Round to the nearest next whole unit.
Part 2: Baby Center Ltd. has been approached by the government, which is seeking to buy 12,000 high chairs for its day care centers in 2018. The proposed government contract states that the government would pay Baby Center a price of $36 per high chair. If Baby Center decides to accept this special order, they would avoid packaging costs for this contract as well as all variable selling and administrative costs. The company's capacity is limited to only 40,000 units. If they accept the government contract, they will need to increase their capacity by renting an additional machine. Refer to page 1 for the company's estimated cost data and additional machine rental cost.
Assume that Baby Center does not adopt the proposed Marketing Plan and that the company's production and sales level without the government contract is expected to be 30,000 high chairs for 2018.
1. Prepare an analysis below to determine the incremental net income or net loss that Baby Center would recognize if they accept this special order.
2. Should Baby Center accept or reject the government contract?