Case Name: Baldwin Bicycle Company

Case Name: Baldwin Bicycle Company

Student Name:

Student Number:

Short Cycle Process

Who: Suzanne Leister, marketing vice president

When: May 1983

Where: America

Issue 1: “Relevant” cost of manufacturing a Challenger bike

Materials, labor and overhead costs are included to produce a Challenger bike in the estimated first year cost. But according to the accountant, only 40% of total production overhead is variable. The management accounting concept used is relevant cost.

Analysis: To determine the relevant cost of manufacturing a Challenger bike, only the 40% variable overhead cost is considered. The rest 60% of overhead cost is fixed cost which is a sunk cost and is not included in the relevant cost. According to exhibit 1, the relevant overhead cost is $9.8 and total relevant cost is $69.2. Only considering the relevant cost, Baldwin Bicycle Company can have incremental profit of $577,250.

Recommendation: Based on the above analysis, the Baldwin Bicycle Company should accept the proposal from Hi-Valu if only consider the relevant cost. But the other costs should also be considered when making the decision.

Issue 2: “Relevant” cost of carrying the working capital investment

Besides the relevant costs mentioned in issue 1, there are also costs of carrying the working capital investment including costs related to inventory and accounts receivable. The management accounting concept used is relevant cost.

Analysis: Costs incurred when Baldwin Bicycle Company stores the inventory over a certain period. The inventory handling costs are considered differently for different stages. For raw materials and finished goods, the costs include pretax costs, record keeping costs, inventory insurance, state property tax on inventory, inventory-handling labor and equipment and pilferage costs, totaling 23.5% of asset-related costs. For WIP inventory, the asset-related costs would less the inventory-handling cost, which is 20.5%. Besides the inventory handling costs, there are cost relating to finished goods being stored in Hi-Valu regional warehouses (average 2 months) and accounts receivable costs (1 month) since Hi-Valu would pay for the bicycles within 30 days.. The asset-related costs would include pretax costs of funds and record keeping costs which is 19%. So according to Exhibit 2, total costs of carrying the working capital investment on a per bicycle basis is $5.98.

Recommendation: Baldwin should accept the Hi-Valu proposal after considering the relevant cost of carrying the working capital investment. There is incremental profit of $ 427,660.88. But the Company still needs to consider erosion cost.

Issue 3: Erosion cost

If Baldwin Bicycle Company accepts the proposal to produce Challenger bicycles, it will lose about 3,000 units of regular sales a year. This is the erosion cost which should be considered as well. The relevant erosion cost is the contributions margin. The management accounting concept used is erosion cost.

Analysis: Baldwin Bicycle Company sold 98,791 bikes in 1982. According to Exhibit 3, the sales revenue per bicycle was $110.05 and the cost of goods sold was $66.73. So the 3000 units of lose would result in $129,948 erosion cost. Even though erosion cost may seem negative since the company would lose regular sales, partnering with Hi-Valu may enable the Baldwin Bicycle Company to develop its business and opens a new opportunity.

Recommendation: According to Exhibit 3, Baldwin Bicycle Company should accept the Hi-Valu proposal. There is still an incremental profit of $297,713 after deducting the erosion cost. But other factor such as cash flow and strategic position may also be considered when making the decision.

Issue 4: Return on Investment

After considering relevant cost, working capital investment cost and erosion cost, the incremental return on investment for the Challenger deal can be estimated. The management accounting concept used is ROI.

Analysis: When evaluating the efficiency of an investment, return on investment (ROI) is over used. ROI can measure the amount of return relative to the investment’s cost directly. In the first year, there is a one-time added costs of preparing drawings and arranging sources of $5000. But from year two on, this one-time cost is no longer considered. According to Exhibit 4, the incremental profit in year 1 would be $292,713 and ROI would be 14.53%. From year 2 on, the incremental profit would be $297,713 and ROI would be 14.82%

Recommendation: If only consider the ROI of the proposal, Baldwin Bicycle Company should accept the Hi-Valu proposal. The deal looks profitable according to ROI. But besides ROI, other factors such as cash flow and strategic position should also be taken into consideration.

Issue 5: Major cash flow

Cash flow is important to the company. In order to maintain and grow its operations,  a company needs to generate sufficient cash inflow. When assessing the proposal, cash inflow and cash outflow need to be considered. The management accounting concept used is cash flow.

Analysis: Hi-Valu wanted to carry inventories in its regional warehouses but the title will only be passed until the bicycle was shipped to the store. And a bike is estimated to stay in the warehouse for two months. Besides, Hi-Valu would pay within 30 days after the shipment. So the cash inflow will only happen within 3 months. And cash inflow occurs about 4 times a year. According to Exhibit 5, cash outflow for 3 months would be $524,375 while cash inflow for 3 months would be $576,812.5. The cash inflow is too slow for the Baldwin Bicycle Company.

Recommendation: According to the analysis, cash inflow occurs every 3 months while cash outflow happens every month. So it is too slow for cash inflow to cover the production. If only consider the major cash flow of the Challenger deal, Baldwin Bicycle Company should not accept the deal.

Issue 6: Baldwin’s financial situation

Analyzing Baldwin Bicycle Company’s financial situation at the end of 1982 would help decide whether to accept the Hi-Valu proposal. The management accounting concept used is financial ratio.