Toy World, Inc.

Toy World, Inc. is a fairly healthy toy manufacturing business that is looking at a cross roads in it's main operating procedure. Jack McClintock is President and partial owner of Toy World. His new production manager, Dan Hoffman, has been on the job through one business cycle (about one year). This toy business is a seasonal business with most of the sales coming between August and December. Since its inception Toy World has followed a seasonal production schedule to match customer demand.

After Hoffman's short time one the job he has become concerned with Toy World's method of scheduling production. He has urged McClintock to change methods to a level production schedule (same amount of production hours each month). Hoffman's main arguments are that Toy World could save money at about $225k from overtime premiums during peak production times as well as an additional $265k from a more orderly production process. Hoffman has also conceded that part of the savings would be offset by about $115k in additional storage and handling costs. Another important factor in Hoffman's case is that Toy World will approach full capacity during 1994's peak season production. Due to recent expansions Toy World has a strained working capital position and would most likely have trouble affording another expansion in the near future. McClintock knows that Hoffman may be onto something but there is more to this decision than meets the eyes.

With a first look at the financials and Hoffman's case to move to level production schedules it seems to be a no-brainer for Toy World. Looking at exhibit 4 the income statement for a level production type in 1994 shows a Net Profit of $538k; a difference of $187k (exhibit 5). This increase is powered by the $490k savings from reduced overtime and orderly production. The favorability is partially offset by the extra $115k in storage, $93k in extra interest, and an additional $95k in marginal tax. If the Net Profit is put to a Net Present Value (NPV) based on a fifteen percent discount rate (11% premium over Toy World's risk free rate of 4%) with no terminal value the switch in production methods is worth $163k in 1994.

However good the financials look, McClintock must also weigh the intangible factors in the production schedule switch for Toy World. One of the biggest favorable factors that is truly hard to put into pure financial numbers is the switch would solve Toy World's upcoming capacity issues. Per Hoffman's analysis Toy World would have to run at full capacity (16 hours per day) during the peak season to meet the upcoming sales demand if they are to continue the seasonal production schedule. Under the current system Toy World would only run at 25 Ð'- 30% capacity during the first seven months of the year and then run near full the remaining five months. If Toy World were to switch to the level production schedule system then they would most likely run at a constant 60% to capacity.

Also, if Toy World were to run at a consistent capacity then they would also be able to keep a consistent work force. Not only does this help with the cost of training and recruiting, as per Hoffman, it also builds goodwill with the Toy World production employees. The employees will be happier as they know that their jobs are secure.

However, not all the intangible aspects are positive. One potentially negative issue that McClintock should be concerned with is that currently Toy World sets it's production schedule to customer orders. In a level production environment sales forecasts per product type would dictate what should be built. Any incorrect estimates and not enough products may be produced, or even worse too many products may be produced. This could easily happen as sometimes product sales vary by 30 Ð'- 35% per year. If Toy World were to produce too many of one product they may be forced to either sell at a loss or hold the product for next year in hopes that there will be additional demand for it then.

Another thing that should concern McClintock is that producing on a level basis means that inventory will have to be built without much cash coming in. Meaning that Toy World's already weak cash position will most likely become weaker during the low sales months. Exhibit 3 details the expected cash position on a monthly basis. It had been previously determined that Toy World would need to have at least 200k of cash on hand at the end of each month as this is considered the minimum required amount to operate the business. In order to calculate cash on hand the beginning cash is added to the total cash in and then subtracted from the total cash out. To calculate cash in Monthly Sales are added to the net change in Accounts Receivable then interest income is added and finally Line of Credit disbursement is added. Cash