Relevant Cost(Revenue)
• Relevant cost (revenue) are future costs
(revenues)that differ across alternatives.
• Thus to be relevant:
– Must be a future cost
– Must differ from one alternative another
* The ability to identify relevant and irrelevant
costs is an important decision making skill
The case reinforces decision
making themes encircling:
• Cost behavior analysis
• Profit contribution analysis
• Long-run vrs short-run product and customer
profitability
• Inventory and receivables carrying cost
• Working capital management
• Project return on investment
• Balancing quantitative and qualitative issues in a
decision
Calculation of additional WC
Requirement
Raw materials(2 months)
$160,000
Work in Progress (1000 units)
55,000
Finished units in factory
35,000
Finished units in Hi-Value Warehouse
280,000
(2 months @70)
Accounts receivable(30 days) 185,000
Less trade credit offset
Assuming 45 days credit from Suppliers) (120,000)
Extra Investment
595,000
• Incremental profit after tax= $288000(appx)
(92-69)x25000x.5
• Incremental capital charge= $100000
• Incremental residual income= $188000
• Incremental return on investment=
188000/600000=31% (subject to the test of
time value of money)
Caveats
• The consigned Inventory Issue- Should one tolerate this sort of
imposition on normal business terms?
• The capacity issue- is it wise tie up the excess capacity(unused
currently) for several years at well below normal price?
• The long run/ short run issue- is is appropriate to ignore fixed
overhead in a project that uses 20% of capacity for 3 years?
• The uncertainty of Hi- value demand-- what happens to the
incremental analysis if Hi-value takes fewer than 25,000 bikes
or more than 25000 bikes?
• The incremental debt capacity issue- can Baldwin borrow
incremental $600000 to finance the project?
The Distribution Step in the
value Chain
One of Baldwin’s
Current Dealers
Margins X Asset Intensity X Leverage= Return
(P/S)
(S/A)
(A/E)
$255000/10.8M
$10.8M/8.0M $8.0M/3.0M=
2.36%
5%
Average U.S.
Baldwin with
HI-Value deal
(at best)
400000/12.8M
(3%)
1.35
1.5
12.8/8.6
(1.49)
2.67
2
8.6/3
2.87
= 8.5%
= 15%
=13%
• Break -even point= (1.5M+2.4M)/$44=89K(approx.)
• One shift Capacity= 133 K
• If it would have run in full capacity- PAT would have been
=(133-89)x44=$1.9M
• Inventory Turnover= 2756/8045x365=125 days
• Account receivables=45days
• Fixed manufacturing cost /sales= 14% (appx)
• S & A/sales= 22% (appx)- to high
• Gross Margin= 26%(approx)- to low