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JET2 Financial Analysis (V2 GRADUATE-0212)

JGT2 Decision Analysis (V2 GRADUATE-0710

Competition Bikes, inc,Executive Summary Report

Horizontal, Vertical, Trend and Ratio Analysis

The assessments of the financial health of Competition Bikes, Inc. (CB) are derived using

the attached income statements and balance sheets. Focusing on calendar years # 6, 7 and 8 to

gauge the growth and stability of this company.

Between the years # 6 and 7, Competition Bikes, Inc. had a significant growth in new

earnings that was not extended on into year # 8. The net earnings moved from a positive 313.4

% to a dramatic loss of 81.6% .

A.1.a) Horizontal Analysis Results

Horizontal Analysis is a direct comparative analysis of each line item across the same

time frames of a particular company. It is calculated in dollars and percentages. An analysis will

look at how the accounts have fluctuated from one year to the next.

The formula used is:

Dollar change = This Year’s Balance – Last Year’s Balance. Percent change = Dollar Change .

The income statement from year # 6 to year # 7, exhibited a sales increase of 33%.

There was only a 31 percent increase in product costs. This decrease in cost of materials was

offset by sales expense of 33 percent and an increase in general operating espense – totaling 20

percent.. These line expenses both increased from year # 6 through year # 8. These increases

offset the profit from an increase in sales. CB experienced greater gross profits in year # 7 than

year # 6. The balance sheet also shows a growth in assets. Total assets increased by 2.9%.

Liabilities increased to only a slight 1.2% . This is a positive indicator of growth for Competition

Bikes, Inc.

A comparative review of the CB income statement from year # 7 to year #8, shows a

decrease in sales by 15 percent. Product costs went down by 14 percent and sales expense

decreased by 15 percent. The general operating expense increased by 1 percent. The decrease in

product cost and sales expense was not significant enough to offset the decrease in sales. The end

result was a dramatic decrease in net income by 82%. The balance sheet shows total assets

decreasing by – 0.1% with liabilities also decreasing by -1.9%. This is a positive sign of

efficiency.

“The horizontal analysis will provide an analysis of the financial performance of

Competition Bikes, Inc. and provides an overview of potential trends of the

company .”(Ashfaq, n.d.).

The years # 7 and 8 utilizing the horizontal analysis further shows that total revenues

decreased by 15.0% . Total expenses decreased by an impressive 69.1%. The result was

earnings before income taxes (EBIT) decreased 313.4% and net earnings reduced 81.6%.

INCOME STATEMENT

A horizontal analysis of CB is derived utilizing the income statement for Years 8, 7 and 6.

Competition Bikes, Inc.’s financial strength was solely relied on by use of their income

Statements. It revealed a decline in growth in year #8 from year #7 . A 15% decline in

net sales resulted in a 16.3% decline in overall gross profit.

The 15% reduction in sales is an overall operational area of concern. The decline has

been attributed to a decrease in the economy.. It is anticipated that sales trends will remain

steady for the next three years. For CB to recover from a such a steep decrease in sales, new

fiscal policies are necessary to remain a solvent company.

Since sales were down, the products were not manufactured and the cost of goods sold is

aligned with this reduction. The Gross Profit was reduced also because of the lack of sales and

can affect future expansion of CB.

Operation Expenses

The operational expenses seen a 3.6% decline. This decline was not equal to the decrease

in revenue. Management must keep expenses related to sales income. If they had kept in line the

operational expenses would have declined in lieu of increased.

There are a few areas of concern within this area that must be addressed.

Selling Expenses

Sales expenses are reduced by 14.9%. This is consistent with the reduced sale. Sales is

remunerated by a percentage.

The reduction in sales paralleled the reduction in total sales expenses. Notably was the

decrease in advertising costs by 16.3 percent. A reduction in advertising can be partially

attributable to the decrease in gross sales.

The Cost of Utilities steadily grew. CB experienced an 11.1% growth. This would not be

suspect except why did utilities needed for production increased when production decreased.

In addition to the utility costs, all other general and administration expenses increased by

7.6 percent. This is of concern, besides utilities, all other costs were either below or even with

year # 7.

Balance Sheets and Total Assets

CB reduced the accounts receivable account by 15 %. The horizontal analysis of the

current assets shows that the assets have grown 16.5% from year 7 to year # 8. The result of

collecting on accounts receivable was an infusion of $ 107,640 dollars. The cash balance rose

275.4%.

Analysis shows that the accumulated depreciation was reduced by $ 230,000 or 50%.

The total assets were reduced by 0.1% or $2, 400.

Liabilities

With a reduction of Accounts Receivable, the cash infusion was apparently partially used

to reduce the total liabilities by $ 38,500 or 1.9 percent. These reductions were in the long term

liabilities column. Reducing Mortgage and other long-term liabilities.

A significant line of concern on the balance sheet is the increased purchase of raw

materials with a decrease in sales. This explains the unexplained increase in current liabilities of

28.5%.

A.1.B ) Vertical Analysis Results

Vertical analysis is a method of analyzing financial statements against net sales of

the company. This analysis will illustrate how one credit or debit can have a positive or

negative effect on the net sales profit.

Income Statement

The income statement of CB, vertical analysis shows the following results.

Gross Profit is the total sales minus the cost of goods sold. Net sales profit is determined

by crediting the fixed general operational expenses to the cost of goods sold. This determines

profit. Gross sales profit is an indicator of the company’s profit on all goods sold. The

significance of this number is maintaining market share and the viability of the product. Gross

sales allow for a cash influx to maintain operations. An analysis identifies weaknesses to discuss

potential remedies needed to increase the gross profit ratio. The gross profit ratio is determined

by the following formula:

Gross Profit Ratio = Gross Profit/ Net Sales

An analysis of the income statement of CB was performed.

Gross Profit for CB is assessed as:

Year 8 Gross Profit - 1,371,400- net Sales Year 8 / 5,083,000 = 27.0%

Year 7 Gross Profit- 1,638,000 - net Sales Year 7 / 5,980,000 = 27.4%

Year 6 Gross Profit - 1,191,000 -net Sales Year 6 / 4,485,000 = 26.6%

The GP is trailing down. This is after a record year in - #7. This creates concern,

particularly when compared to year 6 when the GP was 26.6%. A GP of 27% is considered a

nice reasonable profit. CB needs to pay particular attention to this decrease. A decrease in GP is

a decrease in cash flow, market share and will affect CB’s net earnings. This decrease will

affect the ability to generate cash reserves..

Operating Expenses Ratio (OER) is to determine the cost of normal business operations.

The formula is calculated as follows:

OER = Operating Expenses/Net Sales

Operating Expenses for CB were assessed as:

OE Year 8- 1,273,867 / Net Sales / 5,083,000 = 25.1%

OE Year 7- 1,322,075 / Net Sales / 5,980,000 = 22.1%

OE Year 6- 1,066,895/ Net Sales / 4,485,000 = 23.8%

Year 6 assets represent 24.5 cents out of every dollar and total liabilities are 47.5%.

Year 7 assets were increased to 31.9 cents. This was possible by the accounts

receivable increasing from 6.5% to 16.6%. Liabilities decreased to 46.7%.

The financial statements show that operating expenses are 25.1% of every dollar made by

CB. These expenses include sales expenses, general and administration expenses.

Year 8-

Since year 7, the operating expenses have increased 3%. It is most notable with a reduction in

sales in year 8. Most significant is the sales expenses were not reduced in year 8 consistent with

the major reduction in gross sales. Steadily, the sales expenses stay within 6.7% of gross sales.

Appropriate reductions were not made in sales advertising in year 8 . Sales Commissions were

lower due to the lower sales. This is an indication, CB had established sales commissions

according gross sales. Sales commissions have maintained at 3% of net sales.

General and administration expenses increased steadily. Specifically, there was an

increase in the cost of general and administration expenses from 15.5% to 18.4%. One notable

reason for this increase was that salaries were increased in year 8.

Executive Commissions increased from year 7 to year 8 . Sales income needs to be

directly related to sales profits. This may be an indicator of CB not being in financially good

health in the near future. If their remuneration was directly linked to their net profit, then the

percentage would have stayed more consistent..

The cost of general and administration expenses rose in year 8 by $12,000 or 0.7%. This

Figure is an additional indicator that the financial health of CB is deteriorating.

Executives need to adjust and control expenses.

Net Earnings for CB years 8, 7, 6:

Net Earnings Year 8- 36,100 / 5,083,000 = 0.7%

Net Earnings Year 7- 196,294 / 5,980,000 = 3.3%

Net Earnings Year 6 - 47,479 / 4,485,000 = 1.1%

These ratios should be of major concern to CB. They are breaking even between sales

and expenses. This slim margin is indicative that expenses are too high. The 2.6% reduction in

net earnings is below their prior year 6 net earnings.

Balance Sheet

In reviewing the Balance Sheet of CB, the following vertical analysis was performed below.

Current Ratio

Current Ratio is used to determine whether a company can pay its short-term debt.

Current Assets Ratio is determined by the formula:

Current Ratio = Current Assets/Current Liabilities

Current Ratio for CB was computed by:

Current Assets Year 8/ Current Liabilities-Year 8 1,606,817/ 300,200 = 5.35X

Current Assets Year 7/ Current Liabilities- Year 7 1,379,217/ 233,700 = 5.9X

Current Assets Year 6/ Current Liabilities- Year 6 1,029,303/ 105,080 = 9.7X

Although CB’s year 8 Current Ratio is 5.35X, its current liabilities, the continued reduction is a concern..

Competition Bikes, Inc's income performance deteriorated between year 7 and 8.

In year 8, for every gross dollar generated, it retained 0.7 cents. In year 7, 3.3 cents was

retained. The overall profitability of the company decreased.

A.1.C ) Trend Analysis

Trend analysis calculates the percent change in an account over two years or more. This

is to illustrate if the company is moving positively or negatively.

The formula is as follows:

(Any year $ / Base Year $) x 100

Year 6 is used as the base year

To evaluate CB net sales profits for years 8, 7, and 6 the following trend analysis was completed:

Net sales- year #8/ 5,083,000 - year # 7/ 5,980,000 - year# 6 / 4,485,000

COG - year #8/ 3,711,600 – year # 7/ 4,324,200 – year # 6/ 3,294,000

Gross Profit- year# 8/ 1,371,400 - year # 7/ 1,638,000- year #6/ 1,191,000

Sales Expense - year # 8/ 338,748- year # 7/ 397,960- year # 6 / 299,220

Total G&A Expenses- year# 8 / 935,119- year # 7 / 924,115- year# 6 / 967,675

Total Operating Expenses- year # 8/ 1,273,867- year 7/ 1,322,075- year #6/ 1,066,895

Operating Income – year# 8 / 97,533- year # 7/ 315,925 – year# 6 / 124,105

EBIT- year # 8/ 48,133- year# 7/ 261,725- year #6/ 63,305

Net Earnings – year # 8/ 36,100- year # 7/ 196,294- year# 6 / 47,479

Net Sales – year # 8/ 113.3%- year #7 / 133.3%- year # 6/ 100.0%

Cost of Goods Sold- year# 8/ 112.7% - year # 7/ 131.3% - year# 6/ 100.0%

Gross Profit – year # 8/ 115.1%- year # 7/ 137.5%- year 6/ 100.0%

Selling Expense – year # 8/ 113.2% - year # 7/ 133.0%- year # 6/ 100.0%

Total G&A Expenses - year # 8 / 96.6%- year # 7 / 95.5%- year 6/ 100.0%

Total Operating Expenses – year# 8 / 119.4%- year 7/ 123.9% - year 6/ 100.0%

Operating Income – year # 8/ 78.6%- year 7/ 254.6%- year 6/ 100.0%

EBIT- year # 8/ 76.0%- year 7/ 413.4%- year 6/ 100.0%

Net Earnings – year #8/ 76.0%- year# 7/ 413.4%- year # 6/ 100.0%

Net Sales decreased in Year 8 in comparison to Year 7. This was calculated by:

Year # 8 Trend : (5,083,000/4,485,000) x 100 = 113.3 %

Year # 7 Trend : (5,980,000/4,485,000) x 100 = 133.3 %

This is a concern since net sales profit was in a decline from Year # 7. However, it did

not fall below year # 6 Net Sales.

Sales should continue to increase annually.. To establish the stability of the company

and the viability of the product.

Cost of Goods Sold for Year # 8 and 7 were evaluated as follows:

Year # 8 Trend : (3,711,600/ 3,294,000) x 100 = 112.7%

Year # 7 Trend : (4,324,200/ 3,294,000) x 100 = 131.3%

In Year # 8, the Cost of Goods decreased compared to Year # 7.

Year # 8 Trend : (5,083,000/4,485,000) x 100 = 113.3 %

Year # 7 Trend : (5,980,000/4,485,000) x 100 = 133.3 %

For Year 8, the trend shows that the cost of goods is reduced but is not in line with the

reduction in sales. The Cost of Goods needs to be evaluated to insure that the proper pricing of

the goods is in line with the sales point of the merchandise..

In EBIT and net earnings, year 7 provided the trend boost with a 413.4% increase in

growth. This was due to the tremendous growth in sales. In year 8, EBIT and Net Earnings

were dramatically reduced even below year 6. This is of major concern. Although sales were

reduced, operating expenses were not reduced to produce a better EBIT and net earnings.

Reduction in expenses should have been made throughout the year as the reduction in sales was

identified.

The trend analysis for year # 8, compared to year # 7. Policy change may be needed

when sales are decreasing and expenses are increasing. This simple business fact produces a

strong EBIT and net earnings dividend .

Trend analysis for future years.

Competition Bikes, INC. Year 11- Year 10- Year 9- Year 8

Net Sales year # 11/- 5,083,000-year # 10/ 5,980,000- year # 9/ 4,485,000- year # 8/ 5,083,000

Trend Percentages – year #11/ 111.8- year # 10/ 107.6- year #9/ 103.2- year #8 / 100.0

In base year 6, the trend percentage is 100%. Year 7 trend percentage is 133.3%. The

year 8 trend percentage is 113%. Although lower than year 7, it is still higher than the base year

6.

This trend analysis illustrates sales in year 8 were 13.3% of year 6 sales. This represents

an increase in balance over a three year period. The results are a favorable impact to the

company. The trend is less favorable in the next three years. From year 8 to 11, the trend

analysis is only an 11.8% increase in sales. This is lower than the previous three-year period.

This would still be a favorable impact for CB. The company will recover from its year 8 losses.

They need to be cognizant and pay attention to their operating expenses to insure profitability.

A.1.D) Ratio Analysis

Ratio analysis examines “the financial infrastructure of the firm, its characteristics, and

the impact of management decisions on financial performance” (Skillsoft, n.d.). The ratio

analysis indicates CB’s ability to pay short term liabilities. Ratio analysis has been

reviewed in the summary analysis approach. This concludes all aspects of the companies

financial activities to isolate the following key areas of responsibility:

Liquidity Ratios

“Liquidity ratios measure the short-term solvency of a business solvency.” (Skillsoft,

Ratio Analysis) These ratios are used by creditors to evaluate if a company has the ability to pay back its obligations and liabilities.

The liquidity ratios for CB will also determine how well it is performing financially.

These ratios will determine cash reserves and availability, inventory turnover and the

management of assets and liabilities.

Current Ratio

Current Ratio is used to determine whether CB can pay its short-term debt. Current

Assets Ratio formula is:

Current Ratio = Current Assets/Current Liabilities

Current assets year 8/ Current Liabilities Year 8 -1,606,817/ 300,200 = 5.35X

Current assets year 7/ Current Liabilities Year 7 -1,379,217/ 233,700 = 5.9X

Current assets year 6/ Current Liabilities Year 6 -1,029,303/ 105,080 = 9.7X

CB’s Year 8 Current Ratio is 5.35X in current liabilities, the continued reduction is a

point of concern. As the ratio continues to decline, the increase in liabilities must be curtailed

until assets recover.

Quick Ratio

Quick Ratio determines how well a company can pay back its creditors. It is utilized to

determine their solvency. If their assets outweigh their liabilities. .

The formula is:

Quick Ratio = Liquid Assets / Current Liabilities

Year # 8 Quick Ratio = ( 445,024 + 220,000 + 609,960) / 300,200 = 4.25 %

Year # 7 Quick Ratio = ( 118,550 + 220,000 + 717,600) / 233,700 = 4.52 %

Year # 6 Quick Ratio = ( 261,000 + 198,500 + 271,503) / 105,080 = 6.96 %

The acid test ratio for year 8 is 4.25. This is lower than year # 7, 4.52. Although, it is

higher than its competition, Two Wheel Racing (2WR). Their ratio is slightly lower at 4.2

Competition Bikes Inc., is solvent and can meet its short-term debt obligations 5.35 times

over. From an investors stand point, this company is performing well. From a creditors stand

point, they are credit worthy.

The quick ratio analysis indicates that CB continues to increase its risk in covering its

immediate liabilities. If this ratio continues to decline, this will result in a risk of increased

financial problems or their ability to receive credit lines. Another indicator of the analysis is that

inventory is accumulating. 2WR is excelling CB in most all financial areas. 2WR’s Gross

Profit is 32.10 % compared to CB’s Gross Profit of 27.0%

CB has a weakness in their P/E Ratio of 83.73. 2WR P/E Ratio is 29. Stockholders

may look at this higher P/E Ratio for CB unfavorably. This higher P/E Ratio may be an indicator

that the stock price for CB is overpriced. This possibly could indicate that 2WR’s stock is priced

correctly and allow 2WR possible future growth and strength.

Current Ratio for CB was assessed as:

Current assets Year # 8- 1,606,817 / Current Liabilities - 300, 200 = 5.35X

Current assets Year # 7- 1,379,217 / Current Liabilities - 233,700 = 5.9X

Current assets Year # 6 - 1,029,303 / Current Liabilities - 105,080 = 9.7X

2WR has a lower ability to pay short-term debt than CB . This is a weakness for 2WR.

2WR has a lower average collection period by collecting on accounts faster than CB.

Summary

2WR and CB are very competitive with different strengths and weaknesses. If CB

continues to decrease sales and if 2WR increases sales this year – the following year may be the

end of CB.

A.2) Working Capital Analysis

Working Capital is a measure of a company’s financial health in the short-term. It is

required for production and continuous operations. CB’s working capital is invested in

their inventory and accounts receivable. Working capital also provides an indication of whether

current debts can be paid as they are incurred. Working capital is necessary for the company to

continue a growth pattern. Operating expenses like late fees, could be slowly draining CB of

cash.

“Positive working capital means that the company is able to pay off its short-term

liabilities.” (Investopedia, Working Capital, n.d.)

A definition of working capital is:

Gross Working Capital- is referred to as Total Current Assets.

Another definition is:

Net Working Capital - is referred to as Current Assets – Current Liabilities.

CB Working Capital is as follows:

Year # 8 - $ 1,306,617

Year # 7 - $ 1,145,517

Year # 6 - $ 1,104,223

CB working capital has increased dramatically in one year. It can pay its short-term

liabilities better than in previous years.

Improving Working Capital.

Working Capital is essential in companies for the day to day operations. For CB to

increase working capital, it must evaluate several areas of its operations to include specifically its

collection policy. The first way to improve working capital is to increase sales. By increasing

sales, cash flow increases.

A notable improvement would be reducing CB’s average collection period from 43.8

days to standard 30 days. This policy action will increase cash flow for CB. In year 8 operating

cycle, revealed 46.9 days conversion from capital to revenue. This included 22.5 day payables

outstanding and 47.7 day sales outstanding. CB should negotiate a 30 day net from suppliers and

a 15 day net from customers. CB should be more diligent in their collection efforts.

Consideration should be made on the increase of interest rates for accounts. To impose penalties

for delinquent accounts. This policy would increase cash flow, reduce potential late fees from

CB’s suppliers and could generate funds to support advertising, R&D and ultimately funds to

the net profit.

To improve the working capital for CB, a review of their supply chain and Just-In- Time

strategy would be prudent. Their current strategy of ordering supplies on a monthly budget

instead of a sales trend is resulting in higher raw materials costs. Purchases should be tied to

sales and a specific strategy and not to budgets.

Working Capital to Increase Profits

With an increase in working capital, CU should invest into a lighter frame to compete

against 2WR.

A.3) Internal Controls

“The purchasing department will issue a purchase order to the supplier based on the

monthly budget projections. Purchasing checks with three sources for similar quality

materials and selects the low bidder from the three. The purchase order is sent to the

supplier by the Purchasing Department on the first of the projected month. Upon receipt

of the goods they will be brought to the production line for use during the month. Any

unused parts are sent to the raw materials inventory stores on the last day of the month.

Purchasing sends the suppliers invoice to accounting and accounting writes a check to

pay the invoice (Sarbanes - Oxley Act (SOX).”

Segregation of duties creates a checks and balances system. This greatly reduce the

ability to misappropriate items from the company. The internal controls state that the purchasing

department will issue the purchase order. The expenditure of company funds is under scrutiny by

auditors and is resulting in misinformation about the company’s financial strength. The

prevention of theft and fraud is paramount in an assembly company.

The audit shows the purchase order system as probably the single largest problem in the

company. Many individuals can access the system and generate a payment. The company is

vulnerable to untold losses. Problem, the purchasing department controls the selection of vendors,

purchasing materials and the receiving of materials. This system only pertains to the budgeted

transactions. Purchase agents authorize the purchase and issues the purchase order based on

budgeted amounts.

There is not a solid policy to insure the receipt of goods authorized in the purchase order.

The end result is goods being received that were not ordered or needed..

A.3. A ) Corrective Actions

CB needs to implement the following to be compliant with SOX:

1. Establish processes and policies to an independent or management review of the

three sources who are bidding for the vendor supplier work. To discourage the favoritism of one

of three sources.

2. Establish a separate entity for the physical writing of the purchase order.

3. Implement policies for accurate confirmation of the invoice and the goods. Establish policies

to insure that the goods ordered were delivered. Appropriate payment of the invoice so that the

person ordering and receiving is separate entity.

A.3.B ) Risks

Risks that have been identified:

Financial, the purchasing from a non-qualified resource.

Financial, the receiving of unapproved goods.

The receipt of goods that are not timely delivered causing assembly delays.

The delivery of unnecessary goods in conflict with the Just-In-Time strategy.

A.3.BI ) Risk Mitigation

Area Risk Mitigation

Purchasing from a non-qualified source. The need to implement policy on

review of three bids that include an independent review of the source bids in relation to

1) compliance

2) Independence from resource

Implement management approval and review of all selections of potential sources to

Insure policy compliance and to eliminate the potential for purchases being aligned with internal

resources.

Implement policy concerning the receiving of unapproved goods and receipt of all

goods. Compliance of strict adherence to the purchase order specifications for receipt of

delivered goods.

Implement policy and process concerning appropriate receipt of goods so that goods are

received according to scheduled purchases.

Fraudulent invoices being paid would be eliminated if the process has several checks and

balances.

A.4) Sarbanes-Oxley Compliance

“The Sarbanes-Oxley Act (often abbreviated as SOX) was enacted by the U.S. Congress

in 2002 in the aftermath of several corporate accounting scandals. Accounting problems

at Enron and WorldCom, and other debacles, resulted in a precipitous drop in the

investing public’s confidence in companies published financial statements. SOX was

enacted to bring about reform in companies financial reporting processes, as well as the

internal and external auditing of the financial reporting process. Under SOX, a

company’s top executive, including the CEO (chief executive officer) and the CFO

(chief financial officer), can be held criminally responsible if their financial statements

prove to be fraudulent or materially misstate the firm’s financial condition” (Hilton,

2009).

SOX has become the standard of accounting principles since its inception in 2002.

SOX deals with internal controls concerning financial reporting. These controls include polices,

processes and procedures that are used to accurately determine an accurate picture of a

corporation’s financial position.

Specific internal controls include approval cycles of financials to include expense reports

and invoices, as well as authorizations and verifications of the corporation’s operating

performance, assets security and duty separation and can not only cover the executive

officers but also all employees of the corporation (Hilton, 2009).

Corporate Responsibility of Financial Reports (Section 302)

Section 302 outlines corporate officer responsibility to continually evaluate the

company’s financial internal reporting controls. To implement and evaluate controls for financial

reporting accuracy.

A.4A) Noncompliance Actions

Material Weakness

The CB financial statement has several material weaknesses.

1. Lack of internal controls in violation of SOX “establishing and maintaining

adequate internal control over financial reporting” (SEC, 2003);

2. With missing inventory, an assessment of its liquidity is overstated. “issued an attestation report on management's assessment of the company's internal control over financial reporting” (SEC, 2003).

Recommendations for corrective actions for noncompliant with the Sarbanes-Oxley requirement

Sox Section 404 – Contract an independent auditor to evaluate Competition Bikes Inc., internal controls.

Sox Section 906 – Strict requirements of adherence of corporate responsibility for financial reports.

The directive states that “Management is responsible for ensuring the internal control

Processes to prevent material misstatements from being reported in the financial statements”

but does not report on the specific internal controls over the financial reporting nor identify the

framework that was used to insure and evaluate the internal controls.

The letter does not provide details in its assessment that internal controls are effective.

Simply stating that it is effective based on the COSO is not enough since COSO Internal

Control-Integrated Framework states that “material weakness is considered in relation to an

entity’s financial reporting objective…” (COSO, 2011)

In summary of non-compliance corrective actions. A check and balance of all purchase

orders and received goods would alleviate the majority of compliance and profitability issues. A

thorough implementation of Just- In –Time strategy for raw materials would move CB into a

more profitable venture.

~ Robert Hixon

References

Ashfaq, Qazi. (n.d.) Financial Statement Analysis. Retrieved from http://www.scribd.com/doc/2433224/Financial-Statement-Analysis#

COSO. (2011 Dec). Internal Control – Integrated Framework. Committee of Sponsoring Organizations of the Treadway Commission (COSO). Retrieved from http://www.ic.coso.org/download.aspx

Hilton, Ronald. (2009). Managerial Accounting: Creating Value in the Dynamic Business Environment, 8th Edition, Appendix I. McGraw-Hill Higher Education. (Appendix I).

Investopedia, (n.d.) Working Capital. Retrieved from http://www.investopedia.com/terms/w/workingcapital.asp#axzz1jerG5gE2

Securities and Exchange Commission hereinafter referred to as SEC. (2003, June). Final Rule: Management’s Report On Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports. 17 CFR PARTS 210, 228, 229, 240, 249, 270 and 274. [RELEASE NOS. 33-8238; 34-47986; IC-26068; File Nos. S7-40-02; S7-06-03]. Retrieved from http://www.sec.gov/rules/final/33-8238.htm

Skillsoft. (n.d.) Ratio Analysis for Financial Statements. Retrieved from http://library.skillport.com/courseware//content/FIN0256B.htm?Aicc_sid=lcimino-5METP8RMM-@0-&aicc_url=pvsp71fbe.skillport.com/skillportbe/spwgu/AICC.rbe&cbtlaunch=FIN0256000000000X000001&RESMODE=8&use508=0&COURSEINFO=/skins/option3_35bs4_PC&SIGNED_APPLET=true&DYNAMIC_SKIN_URL=http://pvsp71fbe.skillport.com:80/skillportbe/spwgu/Cmd.be

The Sarbanes-Oxley Act hereinafter referred to as SOX. (n.d.). A Guide to the Sarbanes-Oxley Act. Retrieved from http://www.soxlaw.com/

Task 2

Competition Bikes, Inc.

Budget Concerns illustrated in year #9

A 1) Competition Bikes, Inc. ( CB ) budget for year # 9 contains the required schedules. There

are five remaining concerns.

Concern # 1 – Quarterly Budget

My first concern is that the budget should be further divided into quarters. Bicycling is

predominantly a temperate weather activity. Purchasing of raw materials for the onset of a sales

increase in demand should incur a quarter prior to demand. Conversely, the quarter prior to a

historically slower quarter should have a budget with less purchase of raw materials. Reserve

inventory is satisfactory for an unexpected sudden demand for finished product.

Concern # 2 – Sales Projections

According to Hilton,( 2009)

“The sales budget is based on projections that take into account trend information as well

as market, competitor, and other econometric information to provide an accurate forecast

of future sales.”

The projection of 3,510 sold units in year # 9 is not supported by the previous year #8

sales. In year # 8 there was a 15% decrease in units sold than in year # 7. Optimism of a

return of a sales level rivaling year #7 is appreciated. The reality is that if sales do not rival year

#7 , the budget should have a variance allowance in a post historically slow quarter for an

adjustment in material purchases and other production activities.

Based solely on facts provided by the company, year # 8 reduced sales was primarily due

to a downturn in the overall economic situation which affected professional rider’s sponsorship.

CB also stated that this decrease in sponsorship is anticipated to continue though this year and

the following two years. Based on their own statements, there would not be justification for an

optimistic sales forecast.

Concern # 3 – Uncollectable Accounts

CB’s master budget fails to specify in their cash budget line, reference to uncollectable

receivables. With the production of such a high quality specialized product, economic factors

like lack of sponsorship is proven to be a variable factor that could generate delinquent accounts.

Concern # 4 – Raw material levels

CB is budgeting for 140 unproduced bikes including labor. The Just- In – Time principle

states that although it is preferred to have additional parts the risk is that these parts could

become obsolete. It may be prudent to reduce this level of additional parts inventory. A loss of

possible revenue does not justify the possible loss in asset value due to the parts becoming

obsolete.

Concern # 5 – Utilities Expense

The manufacturing overhead schedule of CB, itemizes utilities at a fixed level. It was

evident in year #8 that utilities expenses increased when production went down. This factor is

compounded in complexity when the SG&A schedule has two individual utilities line items.

One is listed as Utilities and the second is Utilities and Services. Both line items are listed

under Facility and General Operations.

A 2 ) Flexible Budget

A flexible budget is a budget with figures that are based on actual output. This number is

then compared to a company's static budget (fixed) to determine variances or differences. The

difference between what level of expense was budgeted and what was actual. A flexible budget

adjusts for changes in the volume of activity. The flexible budget is more sophisticated and than

a static budget. A flexible budget allows for increases in sales and product demand. It allows for

a larger than normal purchase of a raw materials if a tremendous price reduction becomes

available. The budget is used to determine how effectively a company is planning and

performing. Unlike the static budget, the flexible budget provides management with the actual

number, rather than the planned number.

In a budget the fixed cost remains constant. One positive reason the numbers may

change is an increase in projected sales volume. Variable cost can affect a flexible budget in a

positive light because it allows the company an opportunity to adjust to reduce their expenses. If

a company foresees a decrease in demand, they can reduce their labor and material expenses so

cash reserves can be maintained. Because variable cost may vary, the company has the

possibility to spend less than the planned amount which would produce a favorable effect on the

flexible budget.

A 2a ) My suggestions for correcting my concerns are as follows:

The master budget should be prepared in quarters and not just an annual budget. This

simple adjustment would allow management the flexibility to adjust expenses based on actual

sales revenue. My concerns would all be addressed as the quarter sales and actual expenses and

revenues are realized.

Sales projections are more difficult to project a year in advance than a few months in

advance. If CB does realize an increase in sales, management can increase production and order

more raw materials. If CB realizes a continued decrease in sales then reductions can be initiated

sooner to prevent an accumulation of antiquated parts and head off unnecessary sales expenses

like advertising. This is an example of variance allowances.

In year # 8, CB was successful in their collection of delinquent accounts. By initiating a

policy early in the year of applying accounts receivable to their budget and being diligent in

changing policies, for example: 30 days net from their suppliers and 15 days net from their own

accounts – the results can be reviewed more often and corrections made sooner. An increase in

delinquency would also be an indicator of a decrease in future orders.

CB had a previous policy to order raw materials based on a static budget. With the

implementation of a flexible budget, CB can adjust their need and supply of materials on a more

regular schedule. Their previous compliance issue concerning purchase orders and deliveries

could be more closely monitored in this quarterly budget. The practice of increasing their assets

with antiquated parts would be curtailed. The decision to assemble bikes from parts in

anticipation of realized sales could be forecasted to increase sales revenue without missing a

potential opportunity. The decision to save labor on assembly could also be forecasted utilizing

variance analysis.

In year #8 CB had an increase in utilities expense with a decrease in production. With a

quarterly analysis the utility expenses may indicate a potential unnecessary drain on cash

reserves. If the expense is increasing and production is decreased, an investigation by an outside

firm of the infrastructure may be necessary and warranted. In this instance, variance analysis

would detect a potential waste of natural resources that is happening without managements

knowledge. It is an increase in expense without any explanation.

A 2B ) Management by exception can least best be illustrated by the 4 % annual increase in the

utilities expense. When a projected budget is exceeded. Action by management on any notable

discrepancy in anticipated projections and realized expenses or results is within the role of

management and needs corrective action and further financial analysis.

In this example of a steady increase of utilities expense is not minuscule. It was not a

spike but an increasing large percentage. There is sufficient historical data to determine a budget.

In setting the budget in year seven based on year six of $130,000, then the actual dollar figure of

$135,000 is alarming. Then to set the budget at $135,000 and in year 8, the actual dollar figure is

$140,000. This is an NOT an example of management by exception which necessitates

upper management attention. Subordinate managers can and should be addressing this rising cost.

In a company’s budget variances, management needs to take decisive action. Profit is

made or lost by pennies. Management by exception is illustrated best below:

Dramatic sales or profit decreases in performance and analysis reports are key factors of

management by exception. This is information that the senior management needs to be aware of

to make corrective action. This practice is reserved only for the senior managers that have the

authority and skills to remedy.

Management by exception dictates that a manager's attention should not be directed

towards the parts of the organization where budgets are not being exceeding or that subordinate

managers have the skills to remedy. Time and effort would be wasted by senior management

on areas of the organization with a relatively smooth operation..

If the original plans and budgets are proceeding as planned, the difference between

actual results and initial plans will be minimal. The end expense will fall between standards

If actual results fail to conform to the budget or standards, the performance reporting system

Signals to management of an " exception. The utility expenses are falling out of standards and

increasing.

Not all variances are worth investigating. Differences between end results and budgeted

or planned results are not always the exact same. Every variance cannot be investigated. It would

be cost prohibitive to trace every insignificant variance. Especially for senior managers.

Our example of the ever increasing utility bill is a justified investigation. When

production is down, the utilities continue to increase. Subordinate managers should be concerned.

Managers should decide to investigate variances based on dollar or percentage changes.

Industry standards and relative weather, personnel, holidays, all play a factor on the variances

seen in manufacturing. Percentage or dollar variances at the exact same time as in previous years

could justify a management investigation in the process causing the variance. The most

dependable strategy is to plot variance data to determine a statistical chart. The idea

behind this chart is that many random variance fluctuations from similar time periods are normal

and expected. These fluctuations are expected even with the best budget and control fluctuations.

Reference

Hill Hilton, Ronald W. ( 2009 ) Managerial Accounting: creating value in a dynamic business environment – New York ,Mc Graw – Hill

Task 3

Capital Structure and Budgeting

A 1 ) Competition Bikes, inc. needs to generate a cash infusion for expansion. The options are

bank loans and stock offerings. The focus of this report is to provide analysis as to ultimately

merge or acquire Canadian Biking, inc. by Competition Bikes, inc. This report will

concentrate on the following five key areas and give recommendations on the following:

1) Capital structure approach options

2) Capital structure approach justification

3) Capital budget concerns

4) Working capital for acquisition and expansion

5) Expansion recommendation to either – acquire or merge

“Capital structure is the manner in which a firm’s assets are financed; that is, the right-

hand side of the balance sheet. Capital structure is normally expressed as the percentage

of each type of capital used by the firm debt, preferred stock, and common equity.”

(Capital Structure Decision, 2002)

To be analyzed are the two main components which are debt capital and equity capital.

The decision on the best capital structure is to analyze many factors including but not limited to

gross sales which is an indicator of the demand and viability of the product, assets, growth rate,

current tax liabilities, potential profitability and changing market demands.

The five primary factors to consider in capital structure are as follows;

“1.Tax benefit of Debt: Debt is the cheapest source of long-term finance, when compared

with other source equity, because the interest on debt finance is a tax-deductible expense.

Hence, debt can be accepted as tax sheltered source of finance, which helps in

shareholders’ wealth maximization.

2. Control: Equity shareholders have voting right to elect the directors of the company.

Raising funds by way of issue of new equity shares to the public may lead to loss of

control. If the main objective of management is to maintain control, they will have to

prefer debt and preference shares in additional capital requirements. However the

company earnings should be such that it is able to repay the debt in time.

3. Flexibility: The capital structure should be determined within the debt capacity of the

company, and this capacity should not be exceeded. The debt capacity of a company

depends on its ability to generate future cash flows. It should have enough cash to pay the

debt obligations. The capital structure should be able to adapt its capital structure with a

minimum cost and delay if warranted by a changed situation.

4. Industry Standards: A company needs to examine industry standards of debt-equity

mix while planning its capital structure. For example Electrical Industry tries to maintain

debt-equity ratio of less than 2:1; Chemical Industry has a conservative debt policy; and

in Automobile Industry government permits a debt – equity ratio of 2:1.

5. Company Size: Companies that are very small must rely to a considerable degree on

the owner’s fund for their financing; they find it difficult to obtain long–term debts.

Large companies can make use of different sources of funds. (kkhsou, 2012) “

Debt Capital is a long term debt. Bank loans and bonds are the two primary sources of

loans. Debt Capital is an expensive form of equity but has tax advantages. The return of

investment has a greater return for the investor or lender. Equity Capital or stock holders equity

has the greatest risk for investors.

Capital Structure Options

“The two principal sources of finance for a company are equity and debt. What should be

the proportion of equity and debt in the capital structure of the firm?” (Manage Mentor,

2003). A number of various theories may be utilized to make a determination. These

theories are known as the net income theory (NI), the net operating income theory (NIO),

the traditional theory, and the Modigliani and Miller Theory (MM).

To make an informed decision on the best capital structure approach. It is best to use a

number of elements, operating structure, assets, sales, assets, growth rate, taxes and market

conditions. These capital structure options were reviewed to determine the best approach for the

Canadian Bikes, inc. merger or acquisition to raise the $600,000 and maximize shareholder

return.

· 9% bonds

· 50% preferred (5%, $50 par) and 50% Common Stock

· 20% - 9% bonds and Common Stock

· 40% - 9% bonds and Common Stock

· 60% - 9% bonds and Common Stock

Canadian Bikes, inc. EBIT figures were considered. Utilizing both the low and moderate

projections. The accompanying tables show the EBIT data. Displayed are each year with the

impact of each of the low and moderate EBIT. The earnings per share of common stock show

both options.

Capital Structure Recommendation maximizing shareholder return

A capital approach that maximizes shareholder return. I reviewed five options based on

two key factors; earning per common share and net earnings. These two factors were the primary

considerations for key reasons. The result returned $15,000 in preferred stock dividends under

each scenario.

To raise the $600,000 for capital improvements my first concern was the earning per

common share. The EBIT for each of the five years, #9 – #13, considering the low projected

sales and the moderate projected sales were considered. The earnings for both in relation to the

per common share was calculated. The result for the 50% preferred (5%, $50 par) and 50%

common stock option is roughly equal. With exception for year # 9 by 0.01. This was based on

the low projection. In summary, the earning for each common or preferred share of stock is the

best when the 50% preferred (5%, $50 par) and 50% Common Stock option is used.

My second factor analyzed was the net income results for each of the five options. In

every calendar year using the low and the moderate projections, the 50% preferred (5%, $50 par)

and 50% Common Stock options outperform all other options. The net earnings exceed tens of

thousands of dollars each calendar year. In the course of the five year analysis, the net income

variances are dramatic. In both categories the 50% preferred (5%, $50 par) and 50% Common

Stock option is the best.

The final factor analyzed was the annual return of $15,000 in preferred stock dividends

EBIT figures from Canadian Bikes, inc. Budgeted Earnings in US dollars

Year/ Low $/ Moderate $/

9 - 74,816 / 109,816

10 - 84,714/ 128,814

11- 94,501/ 148,160

12- 106,872/ 169,568

13- 109,200/ 181,546

Table 1--

Earnings per Common Share Based on Low & Moderate Figures|

Options- Year 9 / Year 10/ Year 11/ Year 12/ Year 13

Low Mod Low Mod Low Mod Low Mod Low Mod

9% bonds 0.016/ 0.043/ 0.024/ 0.058/ 0.031/ 0.072/ 0.041/ 0.089/ 0.042/ 0.098

50% preferred (5%, $50 par) and 50%Commonstock-

0.032 / 0.053/ 0.038/ 0.044 / 0.075 / 0.05/ 0.088/ 0.052 / 0.095

20% - 9% bonds and Common

Stock-0.033 /0.051 /0.038 / 0.061/ 0.043 / 0.071 / 0.050 /0.082 / 0.051/ 0.088

40% - 9% bonds and Common

Stock 0.030 / 0.050/ 0.035 /0.060/ 0.041/ 0.071/ 0.048 / 0.083/ 0.049 / 0.090

60% - 9% bonds and Common

Stock 026/ 0.04/ 0.032 / 0.060/ 0.038/ 0.071/ 0.046 /0.085/ 0.047/ 0.092

Table 2 --

Net Earnings utilizing both Low & Moderate Figures

Five Year Totals Years 9 – 13 Average Earning per Share Based on Low Projection

9% bonds 50% preferred 20% - 9% bonds 40% - 9% bonds 60% - 9% bonds

(5%, $50 par) and Common Stock and Common Stock and Common Stock

50% Common Stock 50%

0.031 0.043 0.043 0.041 0.040

Five Year Totals Years 9 – 13 Average Earning per Share Based on Moderate Projection

0.072 0.075 0.071 0.071 0.071

Five Year Totals Years 9 – 13 Average Net Earning Based on Low Projection

9% bonds 50% preferred 20% - 9% bonds 40% - 9% bonds 60% - 9% bonds

(5%, $50 par) and Common Stock and Common Stock and Common Stock

50% Common Stock 50%

$30,014 $70,516 $62,416 $54,116 $46,216

Five Year Totals Years 9 – 13 Average Net Earning Based on Moderate Projection

$70,186 $110,686 $102,586 $94,486 $86,386

It is my recommendation that CB pursue a combination of approaches to acquire the cash

infusion that is desired. CB should retain 50% preferred stock, offer 50% common stock and

secure debt capital - bank loans or bonds.

A1 a ) While retaining 50% preferred stock the investors with the most to gain and lose will be

insured a guaranteed dividend. The preferred investors will retain control of the company. They

can steer the destiny of the company. They will be undoubtedly become the board of directors

and can decide on dividends to common stock holders in the best interest of the company. The

board of directors can take advantage of tax deductions and pay off debt capital. This strategy

allows the board to incur debt without losing control of the destiny of the company. Retaining

the preferred stock has a dollar value that can be made up with debt capital while retaining

control of the company.

This strategy will result in the highest earnings per share ( EPS ) during the first three

years. During years four and five, securing a 9% bond would generate the second highest EPS.

The option with the greatest return of investment ( ROI ) to the investor is the 50% preferred

stock and 50% common stock.

Internal Rate of Return

The other measure for evaluating the investment is the internal rate of return, IRR. “You

can think of IRR as the rate of growth a project is expected to generate. While the actual

rate of return that a given project ends up generating will often differ from its estimated

IRR rate, a project with a substantially higher IRR value than other available options

would still provide a much better chance of strong growth.” (investopedia, 2012).

A 2 ) Net Present Value: NPV is considered a “sophisticated capital budgeting technique and it

has consideration for the time value of money where as the payback a technique does not. It is

also determined by subtracting the initial cost of the project from the NPV with a discounted rate

that equal to what Competition Bikes cost of capital.” (Gitman, 2008)

NPV compares the dollar value of today to future dollar values. This is adjusted with

consideration of inflation and returns to account.

The formula for NPV is:

NPV = Present value of cash inflow – initial investment

C0 is the initial investment which is a negative cash flow showing that money is going out;

The funds going out is subtracted from the discounted sum of cash flow influx. It is

required that the net present value needs to be a positive number. This factor is crucial in

determining if the decision is a valuable investment.

Criteria for NPV:

NPV greater than $0- then the Competition Bikes, inc. should move forward

NPV less than $0 - then Competition Bikes, inc. should not move forward.

Internal Rate of Return (IRR):

“IRR is more widely used over NPR. The IRR is the discount rate that equates the NPV

of the investment opportunity with the $0. It is compounded annual rate of return that the

company will earn if it invests in the project and receives the given cash inflows.

(Gitman, 2008) “

Criteria for IRR:

IRR is greater than cost of capital -- accept the project

IRR is less than cost of capital-- reject the project

Scenario one with anticipated low demand.

1. Capital improvements of $600,000

2. Ten year depreciation schedule.

The building will be a fixed asset at the end of the ten year term of $200,000.

3. Projected sales projections::

Year 9 – 500 Carbon Lite models

Year s 10- 11 – 1% growth Years 12- 13 – 2% growth

Cost of goods sold will increase proportionately

4. Selling and administrative anticipated expenses for Canadian Bikes, inc. operations:

Year 9 : $250,000 Year 10 : $240,000 Year 11 : $230,000 Year 12 : $220,000

Year 15 : $210,000 Stabilizing after year # 5.

5. Competition Bikes requires a 10% hurdle rate to justify a capital investment.

The IRR, utilizing the worst case scenario with the low demand, is 8.2% IRR. This

factor alone indicates a good project. Acquiring Canadian Bikes, inc. not a certainty but with an

increase in the economy and sponsorships, the return of investment may prove to be a strategic

maneuver.

Moderate demand scenario.

1. Total investment of capital improvements-- $600,000

2. Depreciation tax write offs / credits over the next 10 years.

The acquisition will n asset worth $250,000 at the end of the depreciation schedule. This will be an asset.

3. Anticipated sales:

Year 9 – 500 Carbon Lite models Years 10- 11 – 3% growth per year Years 12- 13 – 5%

growth per year .Cost of goods will increase steadily at about 2% per year

4. Budgeted sales and administrative expenses for Canadian Bikes, inc.:

Year 9 : $250,000 Year 10 : $240,000 Year 11 : $230,000 Year 12 : $220,000

Year 15 : $220,000

5. Competition Bikes, inc. is faced with a 10% hurdle rate to first pursue a capital investment.

The strong NPV was the single most significant factor that most influenced my decision

to endorse this acquisition. With just moderate increases in demand, the returns would be

respectable. Illustrated by the NPV formula. The an outcome of an impressive +$8,447. With a

moderate growth rate of only 3% in years ten and eleven. This growth rate is anticipated to

through the next two years at 5 %. Just moderate growth rates through this analysis indicate

Competition Bikes, inc. have a substantial ability to service this amount of debt.

The IRR theory analysis outcome with a moderate demand scenario produces- a 10.4%

IRR. Analysis dictates this project as a great candidate for acquisition.

The following analysis of the calculations for NPV based are figured on the low and

moderate demand. As demonstrated, the data the NPV under the low demand projection is a

negative $39,281 and the moderate demand projection is a positive $8,447.

Low Demand Moderate Demand

Total Present Value $560,710 $608,447

Investment $600,000 $600,000

Net Present Value - $39,281 $ 8,447

The moderate demand is a positive dollar figure. This demonstrates the optimistic nature

of the merger This merger combines desired technologies and new markets. The acquisition also

will acquire a substantial asset – the facilities.

My primary concern is cost of cogs sold. From years #9 -#13 the COGS budget remains

flat which is not realistic.. This negative impact on the EBIT would could be set off by

depreciation schedules.

My second primary concern is the budget decreases in the sales and administrative

expense. There is no indication that these expenses would decrease Competition Bikes has had

increases in administration expenses when sales were down. If sales increase, how can

administration expenses and sales expenses decrease ?

A3)

The most conservative approach for Competition Bikes, inc. to obtain their working

capital is to would be to lease the building and pay the licensing fee. Accumulation of assets like

the building and the technology is a tangible value..

“Working capital is how much in liquid assets a company has on hand and available.

Working capital is needed to pay for any monthly expenses and any unexpected expenses

that may arise during such time. Working capital is to meet the short-term obligations of

the business, and to build and grow the business. (Wolfe, 2012)”

My recommendation is for Competition Bikes, inc. to pursue the strategy of selling 50 %

common stock and bonds. This will provide the $600,000 funds for operating cash flow and to

acquire the Canadian Bikes, inc. The purchase the buildings and technology will be collateral to

leverage the stock and bond sale.

“Scholars have found over the years that insufficient capital is one of the main reasons

for small business failure, coupled with lack of experience, poor location, poor inventory

management and over-investment in fixed assets, according to the Small Business

Association.” (Mansueto Ventures LLC, 2011)

A 4) Merger or acquisition is the dilemma for Competition Bikes? The best decision is not only

for the company but for the stock holders. Competition Bikes, Inc. needs to determine if a

merger or an acquisition is the best option.

When Competition Bikes, inc. acquires Canadian Bike, they purchased a large market

share. This will increase their efficiency while capitalizing on the key component of this

acquisition, a new market. They will also acquire Canadian Bikes technology. This acquisition

will be less effective than developing a similar technology. They also acquire a valuable real

estate asset.

Competition Bikes, inc. can tax depreciation and potential bond interest tax savings

resulting in a higher dividend to share holders.

Canadian Bikes estimates a 10% increase in gross sales in the next 5 years. This is an

added benefit to the acquisition for Competition Bikes, inc. These competitive factors makes an

acquisition a more savvy venture than a merger. A merger where Competition Bikes, inc. leases

a building, develops a great market share and pays a licensing agreement is conservative but

within five years Competition Bikes, inc. will be the strongest competitive bicycle manufacturer

in North America.

This acquisition will built company assets. Not spend expend cash to just manufacturer

bicycles.

References:

Capital Structure Decision. (2002). Retrieved January 18, 2011, from Harcourt, Inc: http://www.business.auburn.edu/~pagedan/ch16sol.pdf

Krishna Kanta Handiqui State Open University. (2012). Introduction to Capital Structure policies andDividend decisions.http://www.kkhsou.in/main/EVidya2/management/ capital_structure.html

Jason Van Bergen (2010)

http://www.investopedia.com/articles/basics/04/030504.asp#axzz22d5rlK3O

Wolfe, L. (2012). What is working Capital. Retrieved January 24, 2012, from About.com Guide : http://womeninbusiness.about.com

Mansueto Ventures LLC. (2011). Retrieved January 24, 2012, from How to Manager Cash Flow: Gitman, L. (2008). Principles of Managerial Finance 12th edition. Addison Wesley. http://www.inc.com/encyclopedia/cashflow.html

Net Present Value. (n.d.). Retrieved January 22, 2011, from Finance Formulas: http://www.financeformulas.net

Stallman, C. (n.d.). Common Stock vs. Preferred Stock. Retrieved January 18, 2011, from BuckInvestor.com: http://www.buckinvestor.com

McClure, B. (2012). Mergers and Acquisitions: Definition. Retrieved from http://www.investopedia.com /university/mergers/mergers1.asp#axzz1twXn8VBp

Task 4

A1)

Activity based costing accounting (ABC) distributes the manufacturing overhead to

products in a more efficient way, than in the traditional way. Activity based costing specifically

allocates the correct percentage of resources to individual products.

ABC is more logical and a more sophisticated method to monitor and allocate company

costs to objects or products than traditional costing. With traditional costing, the overhead costs

may be allocated exclusively on machine hour basis. ABC identifies the many activities for cost

accounting. Taking into consideration all of the resources a company may consume. ABC then

calculates only the activity cost to produce the product. This critical difference is important due

to some products requiring many activities and some products require few activities.

Activity based costing versus Traditional Costing

The primary difference between ABC (Activity Based Costing) and TCA (Traditional

Cost Accounting). ABC assigns all specific activities and TCA may just calculate machine hours

as the total cost ABC is more accurate and complex, encompassing only activities and resources

to produce individual products. Knowing the exact cost to produce separate different products in

one factory. Traditional Cost Accounting is rather simple and less efficient. ABC with

separating expenses can also identify excess raw material and therefore more closely be in line

with a Just-In-Time strategy. This strategy can reduce the accumulation of possibly

obsolete raw materials and help stream line the production line.

Activity Based Costing was initiated in 1981. The methodology is still in the relatively

new stages of accuracy. ABC has a separate overhead and varies by activity and product.

Conversely, Traditional Cost Accounting was initiated in the late 1800’s. The task of calculating

the specific cost of a finished product under the traditional method was less precise. The cost of

goods simply divided by finished products bone activity. The Activity Based Costing method

calculates the exact expenses to produce each individual product using several activities.

With stiff competition, initiating the latest methods of accounting and production, are

necessary to produce a profit. In the case of Competition Bikes, inc, utilizing the Just in time

strategy ( JIT ) and the Activity Based Accounting would improve Competition Bikes return on

investment.

Excess inventory would be greatly reduced. During different stages of production,

parts would be ordered to insure that production is continued but excess parts would not

accumulate. Implemented correctly, Just in Time would focus on production improvement. This

would stream line manufacturing, efficiency and quality. To achieve improvement in key areas,

requires employee involvement to improve flow and quality.

Activity Based Costing is a more accurate way of costing finished products. This method

makes Traditional Cost Accounting method obsolete. The Activity Based Costing method is

preferred when overhead is too high and there is an abundance of remaining parts. The accuracy

of product costing is imperative. If the analysis of the final numbers of cost of goods is too low,

it would appear that the company was operating efficiently. Conversely, if in fact there was

many parts remaining, the company lost money.

“If a manufacturer wants to know the true cost to produce specific products for specific

customers, the traditional method of cost accounting is inadequate. Activity based costing

(ABC) was developed to overcome the shortcomings of the traditional method. Instead of

just one cost driver such as machine hours, ABC will use many cost drivers to allocate a

manufacturer’s indirect costs. A few of the cost drivers that would be used under ABC

include the number of machine setups, the pounds of material purchased or used, the

number of engineering change orders, the number of machine hours, and so on

( Averkamp, 2004) .”

The total of all activities gives a more precise cost factor accurate cost factor.

Activity Based Costing is steadily being utilized and implemented due to the increase in

overhead costs and the array of different products being produced. The evidence that Activity

Based Costing has become the standard is that machine hours and direct labor hours accounting

is no longer in practice.

Primary reasons Activity Based Costing should be utilized:

1. Activity based costing provides a more accurate overhead cost position.

2. Activity Based Costing gives valuable information to management on operations that add

value and those that do not. ABC is instrumental in capital investments, pricing, organizational

change and product mix.

3. Activity Based Costing can more easily identify production activities and resources..

4. Activity Based Costing has been proven for being effective in controlling costs, improving

profits and productivity. This is an example of not reinventing the wheel. ABC works.

Concerning directly to Competition Bikes, inc. – utilizing Traditional Cost accounting the

Titanium units cost was $239,020 but utilizing Activity Based Costing, the cost of was $232 340.

The traditional costing method analysis shows the titanium frame cost $713. The ABC

method analyses shows the titanium unit at $656. Utilizing the traditional costing method, the

traditional total cost is $1,460 to produce .Activity Based Costing is $1,359. The ABC method

more accurately puts the cost of production of just the titanium unit by $57. The cost to produce

the Carbon Lite unit decreases by $101.

To summarize and support the implementation of the ABC method to replace the

traditional method for Competition Bikes, inc. is primarily because the traditional method uses

a percentage of the total and ABC method uses details of only the precise activities needed for

individual products.

Our product line is comprised of primarily the titanium line - 900 or 65 percent of our

product sales and our carbonlite line is 500 of our product sales or 35 percent. The titanium line

is 50.7 percent of our manufacturing overhead and the carbonlite is 49.3 percent. Under the

traditional method the titanium is 48.5 of our total cost and the carbolite is 51.4 percent of our

total cost. Under the ABC method, the titanium is 44.7 percent and the carbonlite is 55.3 percent.

The ABC method is more precise. We see that the Carbonlite is only 35 percent of our sales but

is 55 percent of our total expenses

This change in methodology brings exact activities into consideration. In quality control

for the titanium line we spend only $2, 104 but for the carbonite quality control we spend

$116,896. In engineering services, the titanium line we spend $12,500 and in the carbonlite line

we spend $62,500.

We need to know our exact production cost to accurately figure our breakeven point and

Pricing on each individual product.

A 2a)

BREAKEVEN POINT

Breakeven is the difference between a business making a profit or becoming insolvent.

Determining the breakeven point for a company is critical to either success and growth or failure.

If management is unaware of their financial situation, if they have incorrect or inaccurate

information they may have an incorrect breakeven point thus selling units at a loss to the ultimate

demise of the company.

To determine a company’s breakeven point, I utilized the accompanying Excel spread sheet.:

Fixed Cost / (Unit Price - Variable Unit Cost)

Sales price – variable costs = contribution margin.

The breakeven analysis point has many variables:

· Selling Price per Unit: The set market value for sales of the product.

· Fixed Cost totals: The Activity Based Costing of production per unit. This is fixed.

· Variable Cost total: Projected total production costs including variables.

· Unit Cost variables: Expenses beyond production control that are unexpected.

· Net Profit forecast: Total revenue minus total cost. Production cost is the breakeven point.

When a company offers many different products, an average contribution margin per unit

determines the fixed cost of the product. Then the profit generated above the breakeven point is

the number of units the division must sell for the company to breakeven. This average or

weighted average has a contribution margin. It measures the expenses the company has to invest

to produce and market the products.

Contribution margin and contribution margin ratio

“Key calculations when using CVP analysis are the contribution margin and the

contribution margin ratio. The contribution margin represents the amount of income or

profit the company made before deducting its fixed costs. Said another way, it is the

amount of sales dollars available to cover (or contribute to) fixed costs. When calculated

as a ratio, it is the percent of sales dollars available to cover fixed costs. Once fixed costs

are covered, the next dollar of sales results in the company having income.

The contribution margin is sales revenue minus all variable costs. It may be calculated

using dollars or on a per unit basis ( Cliff Notes, 2012)”

The accompanying Excel spreadsheet was utilized to calculate the breakeven point for

Competition Bikes, inc

Example of the formula:.

The ABC method utilized to figure the breakeven point, must have accurate figures.

Periodically, with an increase in production the breakeven point of a product increases. To

determine the new breakeven point, requires new fixed and variable costs input. into the

spreadsheet that was created. This will provide the new breakeven point.

Example:

The individual breakeven point per unit is accomplished by calculating the product mix.

The titanium line divided by the total and the Carbon Lite divided by the total. A weighted

margin is arrived at $181.71. If $ 399, 943 is the fixed cost then divided by breakeven of $181.71

the total sales of units required is 2201 units.

Weighted average with the titanium line of 900 in sales at nearly twice that of the

Carbonlite with 500 sales. The weighted average contribution margin is $181.71. Individual unit

calculations are $ 221 for each titanium sale and $ 111 for each Carbonlite sale.

Net earnings to remain constant would require more sales to break even.

The San Diego plant has a breakeven point utilizing the Cost-Volume-Profit method. The

number of sales for the Titanium line is 1415 units. The breakeven point for the Carbon Lite line

is 786 units. The Titanium line breakeven point in sales revenue is $1,273,500 The Carbon Lite

line breakeven point is $1,175,070 in sales revenue.

A2b)

BREAKEVEN ANALYSIS CHANGE

It is common knowledge that if a company’s fixed and variable expenses increase then

the end product must increase in price. If the company is forced to increase their fixed costs by

$50,000 and if vendors increase material costs by 10 percent. Competition Bikes, inc. must

increase their per unit sales price to achieve the same breakeven point. This may be avoided if

the company negotiates a decrease in supplies for the purchase of a higher quantity, They must

be careful to not end up with excess inventory at year end.

Cost-volume-profit ( CVP ) is utilized to analyze how an increase in raw materials and

reduced production can negatively affect a company. A CVP analysis must include sales,

administrative costs and manufacturing costs. These expenses should be labeled variable or

fixed.

Sales price per unit is constant per schedule- fixed.

Variable costs per unit are fixed and constant.

Total fixed costs are fixed an constant.

Assuming everything produced is sold.

The affects of costs are only because of activity changes.

All products produced by a company are sold in the same mix

Example of utilizing the CVP. When the fixed costs are increased by $50,000 and with an

increase of 10 percent in raw materials, the results for Competition Bikes inc., the contribution

profit margin for the Titanium line went from $ 221 to $ 191. The Carbon Lite went from $111

to $44.

The weighted breakeven was $690 but increased to $871 for Competition Bikes, inc. due

to the $50,000 over head cost and the 10 percent materials increase. With the decrease in

contribution profit sales price, obviously they must increase sales price and / or increase sales

volume. If we increase our over head an additional $50,000 and we have an additional increase

of 10 percent of raw materials our new breakeven point on sales will be 3254 more units. Nearly

a 50 percent increase.

The cost profit tab shows with the increases in the $ 50,000 overhead and 10 percent

product increase, the Titanium sales price goes to $1415 from $900, the variable cost goes to

$709.30 and the contribution margin drops to $191 from $221. The carbonlite price at $1,495,

the variable costs goes to $ 1,451 with only a contribution margin profit of $44 from $111. The

sales weight average contribution margin per unit is $138 from $181.71. We need to sell 2092

titanium models and 1162 carbonlite models.

With the $50, 000 increase and only a weighted average of $138 from $181 – this

requires an additional sale of 362 units.

In summary, with both of these increases, we will have to increase our sales from 2201 to

3254.

References

Harold Averkamp, CPA

http://blog.accountingcoach.com/taditional-method-cost-accounting/

CliffsNotes.com. Cost-Volume-Profit Analysis. 30 Sep 2012

http://www.cliffsnotes.com/study_guide/topicArticleId-21248,articleId-21229.html

Task 5

NOTE : THE STORY LINE AND NUMBERS FROM YOUR EXCEL ARE POSSIBLY DIFFERENT. DO NOT FEAR THE EXCEL NOTE BOOK. OPEN THE PAGES AND ADJUST ACCORDINGLY

Custom Snowboards, Inc.

Presentation to CFO

A1) Summary Introduction

Custom Snowboards Inc. is located in Minneapolis, Minnesota, USA. Their current sales

are divided as follows:. Currently, 20 percent in the European market, 5 percent in the Canadian

market and the majority or 75 percent of sales are in the United States market. Currently there

are small warehouse and administrative facilities in both the European and Canadian markets to

service respective customers.

Four years ago the company offered shares of the company on the public Midwest Stock

exchange. Jim Swartz, the founder retained 51 percent of the available shares. Custom

Snowboards Inc. management is evaluating a more aggressive market position in the European

market. Among the strategies for an increase in market share is to acquire an already established

European manufacturer that desires to be acquired. The European Snowfun, Inc. acquisition

would require a loan from a bank, for one million dollars.

A bank is performing due diligence and requires an appropriate presentation before

determining a decision. The terms of the one million dollar loan are: 6.75 percent Apr interest,

60 month term and a $300,000 compensating balance fund. This fund is non-interest bearing, the

bank is trustee for use at their discretion for other endeavors.

The final approval or denial hinges on this presentation.

Key Points

A company’s financial picture has key points that could affect and impact a loan

officer’s decision. The primary decision is how the debt would be paid back.

A vertical analysis from a submitted financial statement shows the relationship of items

to the base amount. This is the 100 percent figure. The main points from a vertical analysis

considered are : Net sales from year 12 was at its peak, $6,601,000 with gross profit of

$2,009,000. The following year #13 showed an increase to $6,633,200 net sales and a gross

profit of $2,018,800. In year #14 some concern was that sales declined $225,400 but gross

profits only declined $68,600. This was due to management efforts at cutting operating expenses.

Total sales expense in year #12 was $779,000. In year #13 total sales expense was $782,800. In

year #14 sales expense had dropped to $756,200. Current assets in year # 12 was $738,690.

Current assets jumped up in year # 13 to $ 880,950 but in year #14 dropped to $ 740,155 but

still $1,465 above year #12. Net property and equipment asset value is remaining steady. There

was a drop of $100,000 in year #13 but year #14 held at one million as it was in year #12.

Concerning total liabilities and equity: in year #12- $1,738,590, year #13- $1,780,950, Finally in

year #14 it declined to near year #12 or $1,740,155.

The horizontal analysis key points indicates changes from dollar form. We can

concentrate on the profitability. During year #12 and #13 the percentage of change was 0.49

percent for net sales. During year #13 and #14 results shows a variance of -3.40 percent or

$225,400. A key point to a bank loan officer is operating income. This point or factor is

important because it helps determine if the company has the ability to pay back the debt. The

variance in year #12 and #13 was -23.56 percent or $ 63,500. The variance in year #13 and #14

was -52.91 percent or $109,000 . The variance nearly doubled with decreasing net sales. In year

# 12 and #13, net earnings had a variance of -30.91 percent or $43,350. In year #13 and year

#14 a variance of -82.74 percent or $80,175.

A key point in the percentages of the trend analysis occurs between year #12 and year

#17. Trend percentages: year # 12 - 100 percent, year #13 - 100.5 percent, year #14 decline to

- 97.1 percent, year # 15 increase to 103 percent, year # 16 - 102 percent, finally year # 17

increase to - 103.7 percent.

A2) Risks 

Lenders look for risks in financial statements to find concerns. The simple question is,

can Custom Snowboard, Inc. be capable to repay the loan? Loans are risks to banks. Lenders

require a strong business plan, credit report and financial reports with profitability. The primary

concern for the lender is if the business fails, how may the lender be repaid. If financial

information indicates that repayment is minimal this mitigates the lenders risk.

The capital structure debt to ratio at 100 percent anticipated financing, then EPS is -2.53

percent. Estimated return of 17.2 percent and a estimated share value of -1.47. The capital

structure debt to ratio is positive. With 80 percent financing, the expected EPS is -0.135. The

estimated required rate of return is 14 percent . The estimated share value at -0.96. With only 30

percent financing expected, the EPS is -0.028. The estimated required return is at 11.8. The

estimated share value is -0.23. If the long term debt, which yields 10 percent on the estimated

required return. The capital structure debt to ratio will remain positive.

An expansion into Europe is of major concern and potential risk to the lender. The lender

will need sales forecasts and profitability projections. This is the advantage of acquiring an

established company. In year #15 earnings were $60,118 with a gross profit of $ 310,440. In

Year # 16 earnings were $108, 392 with gross profits of $372,528. In year # 17 earnings further

increased to $166,732 with increased gross profits to $447,034. Earnings continued to escalate in

year #18 to $220,438 with a gross profit of $ 491,737. Earnings and gross profit reached an apex

in year #19. Earnings of $257,665 and gross profits of $ 540,911. The income statements

demonstrate a positive growth pattern. The mitigating factor of the European expansion is less a

factor with such impressive positive growth.

Another risk and concern for the lender is an American company conducting business in

a foreign country. With a changing world, as countries encounter political unrest, economic

downfall and uncertainty, a lender will require collateral for its investment. Mitigating some of

this risk is the North American Free Trade Agreement (NAFTA). This legislation eliminates

most barriers to trade and investment in Canada ,the United States and Mexico. The USDA

(2011) reports that over 70 percent of our exports are high value consumer oriented products

category. The creation of NAFTA created the largest free trade area in the world. This

agreement linked hundreds of millions of people and produced trillions of dollars of goods and

services. This mitigating factor, with regards to a potential trade barrier, actually opened up new

markets, increased economic prospects and prosperity in the United States , Canada and Mexico.

The question of collateral as a risk is minimized by substantial assets held by Custom

Snowboards Inc. headquartered in Minnesota. The land, inventory, equipment, manufacturing

plant, and physical assets could collateralize the loan nicely at the relief of concerns by the

lender. Banks are in the business to make loans. Minimizing concerns and mitigating risks

concerning this expansion to the lender, is recognizing the continued positive growth of earnings

by Custom Snowboards Inc. The collateral and positive growth should secure a loan from the

lender.

A3) Ratio Analysis 

Custom Snowboards, Inc. main competitor is Winter Sports. Their current ratio is 4.2 as

compared to the higher ratios of Custom Snowboards, inc. In year # 13 - 6.82, in year #14- 5.84.

The higher the ratios, is an indication that a business has sufficient current assets for maintenance

of normal business day to day operations. This ratio indicates that Custom Snowboards, Inc is

most likely than not to satisfy its liabilities in the next 12 month period. This is the primary

strength of the company. This ratio also indicates that Custom Snowboards, inc. has excellent

financial strength for the short term. Ratios higher than 1.5 or 2.0 dictate that a company should

secure funds to further expand the business.

    Winter   Custom

Snowboards, Inc.  Sports

Ratio Analysis: Year 14

  Year 13

  Year 14

Ratio:                     Current Ratio 5.84   6.82   4.2           Acid-Test Ratio 3.64   4.66   3.4           Inventory Turnover 33.33   33.41   30.4           Average Collection Period 11.0   11.0   32.5           Debt Ratio 50.4

percent  51.7

percent  38 percent

           Gross Profit Margin 30.4

percent  30.4

percent  32.10 percent

           Operating Profit Margin 1.5   3.1   5.20 percent

percent percent           Net Profit Margin 0.3

percent  1.5

percent  5.14 percent

           Earnings per Share 0.02   0.11   0.08           Return on Total Assets 1.0

percent  5.4

percent  4.80 percent

           Return on Common Equity 1.9

percent  11.4

percent  8.10 percent

           Price / Earnings Ratio 170.52   90.82   29           Times Interest Earned 1.29   2.58   5.1

The quick ratio or acid test determines if a company has adequate short term assets to

manage its immediate liabilities, without having to liquidate its inventory. The higher the quick

ratio or acid test is an indicator of a company’s ability to turn liquidate inventory and current

assets into immediate cash. This insures liquidity of a company. An analysis of Custom

Snowboards in year # 13 is 4.66. In year # 14 it was 3.64. Winter Sports ratios were below 3.4 in

year #14.

Inventory levels are determined by the turnover rate of a company. A high turnover rate

is an indicator of avoiding accumulation of obsolete parts and a high demand. The turnover rate

was lower for Winter Sports in year #14 – 30.4. The turnover rate of Custom Snowboards, inc.

in year #13 was 33.41 and in year #14 - 33.33.

Winter Sports average collection period in year #14 was 32.5 days, nearly three times the

rate of Custom Snowboards, inc. Their ability to convert receivables to cash reserves was only

11 days, in both years #13 and #14. The higher the turnover ratio determines the rate at which

cash is collected. This indicates that Custom Snowboards, Inc (CS) will benefit by collecting

funds at an impressive rate of 30 days or less. Having assets and adequate capital makes CS a

more efficient company that can operate more efficiently.

Debt ratio for Winter Sports debt ratio in year #14 was 38 percent . Custom

Snowboards was 52.5 percent in year #13 and reduced in year #14 -50.4 percent. Debt ratio

compares a company’s total assets to its total debt. This ratio is the proportion of assets financed

by debt. The higher the debt ratio to assets indicates the leveraged amount. The higher the

leveraged amount, the higher the risk to the lender. The positive mitigating factor for this risk is

in future years. This was evidenced by the decline in year #14. The preferred debt ratio is 30

percent. This would improve a company’s credit rating to decrease the proportion of assets

financed by debt.

Winter Sports Gross Profit Margin in year # 14 was 32.10 percent . Custom Snowboards,

Inc. in both year # 13 and # 14 was 30.4 percent . To determine a company’s manufacturing and

distribution efficiency during the production process, the Gross Profit Margin is utilized. This

margin is necessary to set a value of a product and a sales price . The higher the ratio indicates a

more efficient operating company.

After paying the production costs including wages and materials the profit is the

Operating Profit Margin Ratio. This is an indicator of the efficiency that a company is at

controlling costs and expenses related to business operations. Winter Sports for year # 14 was

5.20 percent but for Custom Snowboards Inc in year #13 was 3.1 percent and in year # 14 was

1.5 percent. The risk for the company in this analysis is that for each dollar invested that it

earns roughly 2 cents from each dollar of sales. To mitigate risks basic variables in forecasting

need to be alternating. By decreasing or increasing production the growth rate can manipulate the

demand.

Net Profit Margin is the profit a company makes for every dollar it generates in sales. Net

profit margin is net income divided by sales is the amount of each sales dollar remaining after

ALL expenses have been paid. A higher profit margin is better. Winter Sports has a distinct

advantage with a net profit margin of 5.14 percent in year #14. Custom Snowboards, inc. in year

#13was 1.5 percent and in year # 14 was 0.53 percent. A lower profit margin may indicate a

pricing strategy. A high-volume lower price approach will generate a higher market share. This

still represents that Winter Sports was more efficient and had a greater profit per dollar of sales.

Winter Sports Earnings per share in year #14 was 0.08. Custom Snowboards, inc. in year

#13 was 0.11 and in year #14 it was only 0.02. Earnings per share is the amount of net income

paid or earned for each share of company common stock. Earnings per share is a indicator of the

profitability of a company. To mitigate risks, a company should be diligent at reducing costs and

increasing revenue. Acquiring the European Snowfun, Inc. company may increase earnings per

share.

How profitable a company uses its assets is called return on total assets. Winter Sports in

year #14 was 4.80 percent. Custom Snowboards, Inc. in year # 13 was 5.45 percent but in year

# 14 it was 1.0 percent. The profitability rate is low and the company is in need of

improvements and decisions during an economic slowdown. This is a prime time opportunity to

make some major cost saving decisions. To mitigate risks, the decisions on allocating resources

and the decision to acquire another company needs reevaluated.

Return on Common Equity is the ratio between common stockholder’s equity and net

income. This ratio reveals a corporation’s profitability by measuring the profit a company

generates from the investment from shareholders. The higher the ratio the better the company is

performing. Winter Sports in year #14 was 8.10 percent, Custom Snowboards, Inc. in year #13

was an impressive 11.4 percent. The concern was the dramatic decline in year #14 to 1.9

percent. This was attributed to a total economic slowdown. This analysis presents a low return

on common equity. The company may not be adjusting its spending to compensate for economic

conditions making the company not profitable which is a major weakness. This ratio permits

companies and investors to compare companies profits that their investment earns per dollar. To

mitigate risks, the company might decide to diversify its own investments into several other

assets such as stocks, bonds, or buying other companies like the European Snowfun, inc. This

may prove profitable in the long run.

The ratio of the market price for a share of common stock in relation to a company’s

earnings per share is called the Price/Ratio Earning. The valuation ratio of a company’s per share

earnings and current share price. The higher the P/E is a major indicator of how much th stock is

worth on the market. A low P/E is a weakness and the company stock value is lower with low

investor confidence. Winter Sports, inc. in year # 14 was only 29. Custom Snowboards, inc. in

year # 13 was 90.82 and in year # 14 was an impressive 170.52.

To measure a company’s ability service its debt Times Interest Earned ratio. Higher ratios

are desired. Lower ratios indicate an inability to service debt compared to competitors which is a

weakness. Winter Sports, inc. in year #14 was 5.1, In year # 13 Custom Snowboards, Inc. was

2.91 and in year # 14 it was down to 1.53. Investors find this undesirable and lower earnings

indicate an inability to meet interest payments. In year #13 indicates for ever $1.53 the

organization earns $1.53 worth of income on each dollar of interest expense. To increase the

Times Interest Earned ratio as a mitigating factor is simply to reduce debt. The reduction in

interest expense reduces the debt. This will elevate the Times Interest Earned ratio. This is due to

the income number will be divided by a lower interest expense number. Lower debt and lower

interest expense will have a better debt servicing ability.

The company liabilities during the year is abnormal concerning mortgage payable -

$650,000. The majority of assets are mortgaged. The manufacturing plants, the land, furnishings

net cost is only $900,000 and that was mortgaged. The lender requiring a $300,000 The

company applying for a loan with a stipulation to maintain a $300,000 compensating balance

will further burden the company.

Trend analysis provides economic information concerning the strength of an industry or

an individual business. It dismisses uncertainties in a business concerning slow sales, seasonal

demands and inventory. Trend Analysis is critical to management when making business

decisions with regards to the organizations operations. Historical trend analysis percentages

helps determine future growth in the economic marketplace. Custom Snowboards, Inc. in year

#12 was 100 percent, in year # 13 was 100.5 percent and in year # 14 a slight decline or

weakness at 97.1 percent. The trend analysis forecast in years # 14-17 is more positive. In year

#14 the forecast was 100 percent, in year #15 was 103 percent, in year #16 experienced a

slight decline to 102 percent and in year # 17 experienced an increase to 103.7 percent. The

lender is considering the $1,000,000 loan with terms of 5 year repayment at 6.75 percent

interest, but the catch is a $300,000 compensating balance. The lender will most likely want

additional collateral to mitigate risks. Custom Snowboards, inc. could secure additional

properties possibly from investors. The lender will make its decision on their risks and the

mitigating factors associated with this loan after this presentation.

Presentation to CEO

B1) Historical Analysis

Historical analysis of past performance is an indication of probable future performance.

Jim Schwartz founded Custom Snowboards Inc., in Delaware and the company went

public 4 years ago on the Midwest Stock Exchange. Jim Schwarz retained 51 percent of the

issued shares. The company was relocated to Minneapolis and offers the most reliable and

durable snowboards on the market. The majority of our orders are from retail outlets. There is a

variety of finishes and sizes ordered. The manufacturing cost for individual different products is

consistent and the same in a full production run. We utilize ground shipping for consistency.

We do business with hundreds of retail outlets throughout Canada, the United States and

Europe. Our major market is the United States with 75 percent of our sales, next is the

European outlets with 20 percent and the remaining customers, in Canada with 5 percent . We

maintain small administrative and warehouse operations in Europe and Canada. These facilities

are to serve our customers but they report to the USA main office.

During this worldwide economic slowdown sales have been lower than forecasted.

Snowboards were not an exception. The vertical analysis balance sheet historically demonstrates

net sales in year #12 of $6,601,000, in year #13 we had an increase to $6,633,200. With the

economic decline in year #14 we experienced a further decrease in sales to $6,407,800. This

translates into a decline of the equity earnings per share as indicated in the ratio analysis. Our

competitor Winter Sports in year #14 had an 0.08 earnings per share. Custom Snowboards Inc

much higher EPS at 0.11 in year # 13 and a substantial decline in year #14 to 0.02. Custom

Snowboards is on a steady decline since year #13. Sales increases and cost cutting measures are

necessary to stop this decline.

In year #14 Custom Snowboards, Inc. was at 1.0 percent Return of Total Assets while

our competitor in year #14 was at 4.80 percent. Noteworthy is we fell from year #13 at 5.4

percent . Return of Total Assets is an indicator of the efficiency a company is maximizing

assets to generate earnings prior to paying obligations. Custom Snowboards Inc income

statement indicates that our cost of goods sold experienced a decline in year # 14 at $ 1,950,200 .

From year #13 which was $ 2,018,800 and in year # 12 was lower at $2,009,000. This is

generally good but this decline in COG’s sold was due to lack of sales.

B1a) Future Performance

Trend analysis is a viable method that investors rely on because it is an indicator of

previous results as a base to the future performance. In year # 16 projected sales are $6,535,956

at 102 percent . In year #17, a forecasted peak to $6,647,452 at 103.7 percent.

The sales forecast for future performance trends look promising. Net sales forecasted in

year #14 was $ 6,407,800 at 100 percent in trend percentages. In year #15 we experienced an

increase of net sales is $6,600,034 with a substantial increase to 103 percent . In year #16 our

net sales are projected to $6,535,956 at 102 percent . In year #17 forecasted sales to $6,647,452

at a peak of 103.7 percent. The Winter Olympic Games generated additional interest and sales.

“Trend analysis is helpful because moving with trends and not against them will lead to a

profit for an investor (Investopedia, 2011).”

The comparative pro forma income statement for European sales forecasts future growth

in years # 15-19. In year #15 gross profit at $ 310,440, in year # 16 the trend continues up

significantly to $ 372,528. In years #17 and #18 the increase is considerable. Year #17 -

$447,034 and in year # 18- $491,731. In year # 19 is a real motivator $ 540,911. Our European

sales forecasts should nearly double in the next four years.

B2) Improvement 

Improvement can just be administrative. By initiating cost controls, adopting Activity

Based Costing or ABC versus the current Traditional Based costing. ABC breaks individual

products into many separate activities and assigns costs associated with completing all of the

activities. ABC is more precise and may eliminate a process of an unrelated manufacturing cost

to a product. Cost of goods are calculated more accurately. Traditional costing systems are

obsolete. The system lumps maybe just one process, like machine hours. Our use of the

traditional costing method may have contributed to some of our ratios being inaccurate. The

initiation of the ABC method will give us a more accurate cost to adjust our sales price. This will

assist us in increasing sales. By knowing our cost more precisely, we can possibly not increase

our wholesale price to our retail outlets and realize more profits.

The overhead analysis comparisons are seen under the ABC costing tab in the Excel

workbook. Traditional Based Costing currently states that our cost per unit is $119. Activity

Based Costing has our base cost at $104. Personalized snowboards under the traditional method

are only $ 162 but under ABC is $ 222. The entire manufacturing overhead including

engineering services, quality control, product movements, shipping and packaging including

factory setup totals $ 4,094,317 under traditional costing and only $ 3,569,725 utilizing the

more precise ABC method. With the more accurate method of ABC is more complex and cost

more for initial set up. Traditional costing is less accurate and complex than ABC. because ABC

assigns manufacturing costs to products based on an average rate and more activities.

Unit Cost Comparisons:   Regular    Unit Cost - Traditional $119Unit Cost - Activity Based $104Personalized  Unit Cost - Traditional $162Unit Cost - Activity Based $222

A major area of improvement to increase performance and efficiency is to maximize

fixed inputs like, rental properties, equipment, advertising, and the reduction of variable costs.

Variable costs we can control are packaging and distribution, raw materials and transportation

costs. With ABC method we can arrive at more exact costing and make an aggressive sales

campaign. We can offer free shipping with larger orders, offer our sales department an additional

incentive to increase sales. To adjust our personalized snow boards price up but keep our regular

boards at the same price but with incentives for larger orders. a sense of urgency for employees

to close deals. With this additional discovered profit in the ABC method, we can partner with our

lender that the $300,000 compensating balance be used as collateral for a line of credit for our

retail distributors. This would entice retail outlets to purchase more of our snow boards and our

lender would earn additional interest. It would be a win – win situation. This would increase our

production resulting in increased leverage and profitability.

With stiff competition, initiating the latest methods of accounting and production, are

necessary to produce a profit. In the case of Competition Bikes, inc, utilizing the Just in time

strategy ( JIT ) and the Activity Based Accounting would improve Competition Bikes return on

investment.

Excess inventory would be greatly reduced. During different stages of production,

parts would be ordered to insure that production is continued but excess parts would not

accumulate. Implemented correctly, Just in Time would focus on production improvement. This

would stream line manufacturing, efficiency and quality. To achieve improvement in key areas,

requires employee involvement to improve flow and quality.

“Total Quality Management (TQM) is a management technique that focuses on quality

and continuous improvement. Companies who practice TQM understand the four types

of quality costs, and how they relate to each other (Horngren, 2009).”

There are four types of quality costs.

“Total Quality Management or TQM is an integrative philosophy of management for

continuously improving the quality of products and processes ( Ahire, 1997).”

Prevention costs, internal failure costs, external failures and appraisal costs. Investing in

prevention and appraisal costs can avoid external and internal failure costs. It is calculated that it

is less expensive to pay for prevention and appraisal rather than the unexpected internal failures

on production down times or external failures like service and excessive returns or warranty

claims.

CS would benefit greatly from TQM. An external failure could result from their three

year warranty. If there is a drop in product quality this would prove to be quite costly. This is an

example where prevention and appraisal costs could save the company money. Prevention costs

would be in the area of improving products and employee training. Appraisal costs would be

inspection of products during production and final product testing. These expenses would

provide a better product and save money on replacement under the warranty.

B3) Internal and External Risks 

B3 a) With Recommendations for mitigating risks

There are both internal and external risks associated with our acquisition of Snowfun,

inc. and our aggressive expansion in the European market. Custom Snowboards Inc. is prepared

to expand in the European market in search of a higher market share, profits and new unknown

opportunities.

Internal risks and strategy recommendations for mitigating factors

An important internal factor is the social climate of employees. Acquisitions may put

some uncertainty of employees future as they may see this as a desperate attempt by the

company to remain solvent.

To mitigate this internal risk, I recommend that employees be briefed periodically. To be

assured that the company is stronger than previously believed. To send out a memo that a lender

was so confident in this acquisition that they approved a $1,000,000 loan. Then send out a

memo that an increase in orders was expected due to the new retail outlet finance program and

that over time may be required.

An internal risk is the current European location. That location will probably be closed

and those employees need the most reassurance.

Currently Minneapolis is the main office for our European sales and service. With this

acquisition there will be a tremendous increase in communication between two continents. The

internal problem will be technology and communication. This major risk needs planning and

proper implementation. To mitigate this major factor, negotiations and communication

technology should be resolved immediately. The most efficient and latest technology should be

implemented because of the rapid speed that technology changes. Company policies and

procedures concerning communication will become more critical than before.

A potentially dangerous internal risk is the branding issue. What name will the product

carry and what will the company name be ? Europe is familiar and a large amount of money was

spent on branding Snowfun. The United States where 75 percent of our current sales are

generated are familiar with the name Custom Snowboards.

To mitigate the risk of the loss of brand recognition, I recommend to follow the lead of

Nissan. To also adopt some General Motors branding techniques. When Nissan was first

introduced into the United States it was branded as Datsun. When the company made a name

change, the pickup trucks said NISSAN in big bold letters on the tail gate and down to the left in

smaller letters it read “ By Datsun”. General Motors makes the same vehicle for Chevrolet,

GMC, Cadillac, Oldsmobile and Pontiac. They just call the vehicle a different name with

slightly different options and appointments.

My recommendation is that we increase the wholesale price of our personalized boards.

We promote that the design is inspired by our Europe Sister company. We add to each board in

Europe as did Nissan, “ By Custom Snowboards”. In the United States and Canada, just stay

with Custom Snowboards. If we import to North America our SnowFun product, we just add a

small emblem “ By Custom Snowboards “. We market it like General Motors. The advertising

could be big bold letters By Custom Snowboards – the SnowFun line – Alps tested. We would

quickly be known as one company without losing the valuable brand recognition.

There is an internal risk of the rising input and the manufacturing costs. This will be

minimized be the implementation of the ABC method. To mitigate this factor we need to

immediately analyze all costs to effectively keep manufacturing and other costs to a minimum.

Investors utilize financial statements when evaluating the performance of a firm. The ABC

method will provide more accurate and precise cost of a company’s product. The critical element

to our company is better overall financial statements.

When the European company is acquired, I recommend that the upper management be

temporarily assigned to Minnesota. To teach them about Custom Snowboards. The top

management from Custom Snowboards should be temporarily assigned to Europe. The

management must also be tested as to their loyalty to this new company.

Wholesale pricing to our retail outlets is another internal risk. Our financials have

demonstrated that we have been a high volume company. We have to factor in the value of the

Euro to the Dollar. Will our marketing plan remain as high volume, with quality products and a

growing market share. Consumers have access to any information through the internet. I

recommend that we market as the best “ Value”. If we market that we are the highest quality that

will be heard as the highest priced. To mitigate the pricing risk, marketing managers should

research the European customer. Would the presence of USA ownership help or hinder our

sales? What is the hot buttons of this market ? We have experience in Europe but we are making

a large investment so we need to market and price our product perfectly. This market research

needs to occur prior to our expansion. With the Winter Olympics arrival, we can use this

marketing research to be the snow board supplier for the Olympics and advertise heavily at our

target markets with an already branded product.

An internal risk is the condition of the equipment at this manufacturing facility. Is the

equipment old and not serviceable ? Does it need replaced ? To mitigate this risk, we should send

a team of our current people in Minnesota to inspect and report on their impressions. Prior to

final acquisition price negotiations.

External Risks

Although we have a current minimal presence and risk in Europe, we are investing

heavier in not just another country but an entirely different continent separated by thousands of

miles and an ocean. The presence of an American company can be a major external risk. The

acquisition of a branded company by a foreign company may be viewed negatively. With our

best research efforts, we cannot see the future. If the governments become hostile to each other,

this would most definitely be to our detriment. To mitigate these risks, our company should

become active in the local government and community. To be perceived as concerned about the

community and not just profits. If tensions do occur, we will be positioned to be part of the

solution and not the problem. We will need our managers to be well versed in government

regulations and I recommend that we investigate contracting with an established public relations

firm before announcing our acquisition.

An extreme but possible external risk is if the government decides to acquire our

company. This has happened in other countries over night. Venezuela has current strained

relations with the United States for these exact tactics. To mitigate this risk, our company needs

to adopt corporate social responsibilities. I recommend that we design a corporate exit strategy

prior to the acquisition. We research major pitfalls that may exist if we decide to cease

operations.

A real external risk is current trade agreements. I have given some recommendations but

are they legal in current government trade agreements. We have experience with operating in

Europe but not at this scale. To mitigate this risk the company has to abide by the current trade

agreements. One example is the NAFTA, North American Free Trade agreement that we have to

abide by when trading, manufacturing and sales in Canada.

“ NAFTA is a trade agreement made between the United States, Canada and Mexico that

removed trade barriers for goods and services across their borders. This agreement

govern trade agreements, environmental and labor issues (ehow, 2011).

A external risk as mentioned prior was the Dollar Euro exchange. Currently the Euro is

worth 25 percent more than the dollar. This fact is currently to our benefit. If we sell more

snowboards with this acquisition then we will earn more profits. If this exchange rate changes to

the Dollar being worth 25 percent more than the Euro – we could start losing money on every

snowboard we sell. Mitigating this risk is a large variable, our company will currently capitalize

on the current low dollar exchange. I recommend that we diverse our investments globally with

this initial profit windfall. If and when the acquisition becomes not profitable, we can cease

operations and fall back on less volatile investments and the world standard purchase of gold.

Delivery and distribution is another external risk. Custom Snowboards, Inc. is currently

reliant on ground transportation for 80 percent of deliveries. We have some experience with

delivery to Europe but not delivery from Europe. To mitigate this risk, we should direct our

current shipping manager to attend some trade shows and research to recommend the fastest

least expensive transcontinental shipping mode. I recommend that we work with attorneys in

Europe and the United States concerning import tax rules and regulations. It would not be

prudent to acquire a company, then discover that we are not allowed to own the land as is the

case in Mexico coastal properties. This research by attorneys needs to be completed prior to our

acquisition.

An external risk is European Union Consumer Law. We currently offer a 36 month

warranty. This EU law requires a minimum of a two year warranty. If we acquire Snowfun, inc.,

how much potential liability will be exposed to. To mitigate this risk, we need to analyze their

sales records and repair or replacement records. The key word is minimum. I recommend that if

Snowfun, inc. is providing a probable two year warranty that we factor in the repair or

replacement cost to offer a three year warranty in Europe as we do in the United States. This

would add immediate confidence in our products to add an additional one year warranty.

B4) Potential Returns 

The Custom Snowboards, inc. capital budgeting sheet for the European expansion to

determine the most profitable expansion option.

“Net Present Value is the difference between the present value of cash inflows and the

present value of cash outflows. It is used in capital budgeting to analyze profitability of

an investment. It is sensitive to the reliability of future cash inflows that an investment or

project will yield. Internal Rate of Return is the discount rate often used in capital

budgeting that makes the NPR of all cash flows from a particular project equal to zero

(Investopedia, 2011).”

I have calculated custom snow boards, inc. IRR at 10.8% for the years #15-19. This IRR

exceeds the company’s 10% estimated required return. Based on this analysis of the numbers,

the direct expansion could be given serious consideration. A direct expansion will be profitable

in the future.

I recommend that we lease needed equipment. In the lease versus buy tab on the

worksheet, the present value outflow is $ 653,355 to lease. To purchase needed equipment our

present value outflow is $ 659,426. We need to preserve working capital by leasing, and we

retain $6,071 of working capital. We also have a benefit for any market changes like a downturn

or need of rapid new design changes where new equipment is required.. An outright purchase of

appreciating assets is sensible. An outright purchase of depreciating assets is not sensible.

“I buy appreciating assets, I rent depreciating assets”

John Paul Getty

It is my recommendation that we LEASE any needed equipment. Due to the rapid

advances in technology, our machinery becomes obsolete faster than depreciation tables and the

salvage value for our specialized machines is nearly zero. We would always be utilizing the

latest equipment that would inevitably be more cost efficient. With a lease if the market demands

change quickly we can quickly acquire the equipment we need.

The capital budget analysis clearly dictates the direct expansion option. To expand our

current operations and be in direct competition with European SnowFun, inc. we need to acquire

working capital of $200,000 . It will cost $800,000 for a new building and renovations.

IRR and NRV Definition

“Showing the position of the IRR on the graph of NPV(r) (r is labelled 'i' in the graph)

The internal rate of return on an investment or project is the "annualized effective

compounded return rate" or "rate of return" that makes the net present value (NPV as

NET*1/(1+IRR)^year) of all cash flows (both positive and negative) from a particular

investment equal to zero.

In more specific terms, the IRR of an investment is the discount rate at which the net

present value of costs (negative cash flows) of the investment equals the net present value

of the benefits (positive cash flows) of the investment.

IRR calculations are commonly used to evaluate the desirability of investments or

projects. The higher a project's IRR, the more desirable it is to undertake the project.

Assuming all projects require the same amount of up-front investment, the project with

the highest IRR would be considered the best and undertaken first.

A firm (or individual) should, in theory, undertake all projects or investments available

with IRRs that exceed the cost of capital investment may be limited by availability of

funds to the firm and/or by the firm's capacity or ability to manage numerous projects,

(Investopedia 2012). “

If the board decides to dramatically expand our current operations we would require a

new facility built. It would be better to lease the equipment and pursue a mortgage for the

building because it will appreciate. Custom Snowboards is forecasted an NPV of $28,437 in

Years # 15-19. The translation is that our inflows will exceed the cash outflows. This is a

positive number based on the NPV. These calculations and considerations leads to a

recommendation that Custom Snowboards, inc. should pursue a direct expansion.

The Internal Rate of Return, the IRR for Custom Snowboards, inc. is at 10.8% for the

years #15-19. This IRR exceeds the company’s 10% estimated required return. The internal

rate of return is the return given for a set of investment and corresponding cash inflows using the

time value of money.

B5 ) Summary

To fund this European expansion, we must choose an excellent capital structure to

be cost effective. Custom Snowboards, inc. needs one million dollars to fund the expansion. I

will show the best option in detail below. I will conclude to expand without incurring additional

debt. By offering additional common stock should be used to fund this expansion. This funding

option will forecast the required return of 10.0%.

There are four decisions to consider:

1) Build a new building / Expand current presence and be a serious competitor.

CB will need to decide to buy or lease their facility. Whatever the decision is, it should

retain the highest working capital. Leasing the facility will retain the most working

capital. If CB leases for five years and does a $50,000 buyout, their present value

outflow is $653,355. With a purchase $50,000 down payment, our total present value

outflows $659,426. The difference between the two is $6,701. This means that by

choosing the leasing option, the company is saving $6,701 in working capital.

I prefer the mortgage and the fixed asset option.

2) Merge with European Snowfun

Merging with European SnowFun would raise Custom Snowboard, incs. EPS to $1.24 from

$1.03. SnowFun’s market price per share is over-inflated at $2.40, which has caused their

PE ratio to be inflated. A merger would be one share of Custom Snowboard, inc for three shares

of European SnowFun. The merger option is not my recommended option.

European SnowFun does not offer Custom Snowboards, inc. much. Their products are low

quality and possibly have a negative reputation.

3) Acquiring European Snowfun, inc.

Their NVP and IRR for acquiring the company is acceptable, but

their products will hurt our current reputation and their NPV is just barely acceptable.

With a purchase price of $732,522 and an offer price of $720,000 A profit of $12,000

not worth he risks. Acquiring European SnowFun, inc. – the Net Present Value or NPV is

minimally expected to be 10 percent cost of capital. In year # 15 net present value is $77,345, in

year # 16 net present value is $100,189, in year #17 net present value $123,952, in year #18 net

present value $140,239 and in year # 19 net present value is $144,847. Working capital return is

$200,000. Total present value is $ 959,173, the investment of $1,000,000 results in -40,827 for

NPV. The Internal Rate of Return or IRR at the end of 5 years is 8.9 percent which is 1.1

percent short of the minimum expected cost of capital.

These potential returns do not justify a recommendations for an acquisition of European

Snowfun, inc.

Net Present Value (NVP) is a mathematical formula to assist the profitability of an

anticipated endeavor. NVP demonstrates the difference between present values of cash inflows

and cash outflows. The standard opinion is if a project’s NVP does not exceed zero it should

definitely be rejected.

Custom Snowboards is forecasted an NVP of $28,437 in Years # 15-19. The translation

is that the our inflows will exceed the cash outflows. This is a positive number based on the

NVP. leads to a conclusion that Custom Snowboards, inc. should be a direct competitor.

With the financing options discussed in further detail below’ my recommendation is that

Custom Snowboards, inc. Opt to be a direct a direct competitor and reject the merger or

Acquisition options. Expansion will be profitable in the future. More profitable with less risks

from an inferior product.

Financing Recommendations

The two key factors in finance options is investor and company benefits. The maximum benefits

for shareholders is EPS. Net Present Value (NVP) is a mathematical formula to assist the

profitability of an anticipated endeavor. NVP demonstrates the difference between present

values of cash inflows and cash outflows. The standard opinion is if a project’s NVP does not

exceed zero it should definitely be rejected.

Custom Snowboards is forecasted an NVP of $28,437 in Years # 15-19. The translation

is that the our inflows will exceed the cash outflows. This is a positive number based on the

NVP. leads to a conclusion that Custom Snowboards, inc. should be a direct competitor.

With the financing options discussed in further detail below’ my recommendation is that

Custom Snowboards, inc. Opt to be a direct a direct competitor and reject the merger or

Acquisition options.

4) Build a new building / Expand current presence and be a serious competitor.

CB will need to decide to buy or lease their facility. Whatever the decision is, it should

retain the highest working capital. Leasing the facility will retain the most working

capital. If CB leases for five years and does a $50,000 buyout, their present value

outflow is $653,355. With a purchase $50,000 down payment, our total present value

outflows $659,426. The difference between the two is $6,701. This means that by

choosing the leasing option, the company is saving $6,701 in working capital.

I prefer the mortgage and the fixed asset option.

Financing Recommendations

The two key factors in finance options is investor and company benefits. The maximum benefits

for shareholders is EPS

EPS

Long term debt only

30 percent long term and common

80 percent long term and common

No long term debt

Year 15 0.040 0.079 0.060 0.084

Year 16 0.234 0.150 0.190 0.139

Year 17 0.469 0.235 0.346 0.206

Year 18 0.680 0.312 0.487 0.267

Year 19 0.830 0.366 0.587 0.310

TOTALS 2.253 1.142 1.670 1.006

The chart above varies considerably depending on financing options. The maximum

benefit to shareholders is if CB decides long term debt. This will yield $2.253 EPS that increases

annually. The maximum company benefit is income taxes, interest paid and the net income from

these variables.

Interest Paid on Long Term Debt

Long term debt only

30 percent long term and common

80 percent long term and common

No long term debt

Year 15 $67,500 $20,250 $54,000 $0

Year 16 $67,500 $20,250 $54,000 $0

Year 17 $67,500 $20,250 $54,000 $0

Year 18 $67,500 $20,250 $54,000 $0

Year 19 $67,500 $20,250 $54,000 $0

TOTALS $337,500 $101,250 $270,000 $0

The highest total interest paid is the long term debt exclusively. There is no interest if there is no

long term debt.

Income Taxes Paid

Long term debt only

30 percent long term and common

80 percent long term and common

No long term debt

Year 15 $2642 $14,454 $6017 $19,517

Year 16 $15,607 $27,420 $18,982 $32,482

Year 17 $31,270 $43,082 $34,645 $48,145

Year 18 $45,342 $57,154 $48,717 $62,217

Year 19 $55,359 $67,172 $58,734 $72,234

TOTALS $150,220 $209,282 $167,095 $234,595

The lowest income taxes is the long term debt option and the lowest is no debt option.

Net Income

Long term debt only

30 percent long term and common

80 percent long term and common

No long term debt

Year 15 $7,925 $43,362 $18,050 $58,550

Year 16 $46,822 $82,259 $56,947 $97,447

Year 17 $93,809 $129,246 $103,934 $144,434

Year 18 $136,025 $171,463 $146,150 $186,650

Year 19 $166,078 $201,515 $176,203 $216,703

TOTALS $450,659 $627,845 $501,284 $703,784

The option with the best benefit to CB is to issue common stock and no long term debt. The yield

is also the largest at $703,784.

Financing the expansion with just common stock will benefit CB the most but there will

be no dividends. Income taxes of $234,595 would be paid over five years but zero interest

payments will be attractive to our investors and assist us in a down turn in sales revenue. Our

five-year net income with this option is $703,784. This is the highest and best net income option

possible. This high net income and non-existent interest payments are the main reasons for

selecting this option, as it is the most beneficial for the company.

The EPS continuously increases with the No long term debt option. With an increase in

net income so does EPS. The investors will see slower growth of a stronger company. I caution

that this option only be considered if CB does expand operations in Europe.

Custom Snowboards, inc, should expand and be a direct competitor of European

Snowfun, inc. with only the issuance of more common stock and no long term debt.

B6) Presentation

I recommend to consider stock value to choose the maximum long term debt. The entire

required one million dollars borrowed if possible. This option was chosen due to the capital

structure debt ratio. By preserving stock value the forecasted EPS is -.0.253, this is also the

highest return of investment.

The alternative option of offering additional stock would return of at 17.2 percent. This

is the minimum earnings that would entice a lender to invest into our expansion. The forecasted

share value is $1.47. All other options for this expansion do not preserve stock value. The 80

percent capital debt would put our debt ratio to an estimated 14 percent. Projected EPS is 14.0

and forecasted share value at .96.

The 30 percent long term debt option would have a forecasted EPS -0.028, and a

forecasted return of 11.8 percent. The forecasted share value of this capital option is -0.23.

The least attractive option for this European expansion of Custom Snowboards, inc. is no

long term debt. This option has no expected earnings per share and the forecasted share value

would be zero.

References

Cost Accounting: A Managerial Emphasis, 14th Edition

Horngren, 2012

Horngren, C., Harrison, W., & Oliver, M. (2009). Accounting (8th ed.). Prentice Hall.

Ahire, S. L. 1997. Management Science- Total Quality Management interfaces: An integrative

framework. Interfaces 27 (6) 91-105

http://en.wikipedia.org/wiki/Total_quality_management

http://www.ehow.com/how-does_4565752_nafta-work.html Retrieved 09/21/2012

http://www.fas.usda.gov/itp/policy/nafta/nafta.asp Retrieved 09/24/2012

http://www.investopedia.com/terms/t/trendanalysis.asp#axzz1eUNb39od Retrieved 10/24/12

http://en.wikipedia.org/wiki/Internal_rate_of_return Retrieved 11/12/2012

Decision Analysis

Task 1 with output

To: Shuzworld

From: Robert Hixon Director of Operations

When we face challenges in life that are far beyond our own power, it's an opportunity to build on our

faith, inner strength, and courage. I've learned that how we face challenges plays a big role in the outcome. Stay

ambitious & determined and you can Never fail.

Re: Operations Recommendations

Date: November, 06, 2012

A) Work Flow

The current workflow needs to address how to best organize the assembly line so that it is most efficient,

and what metrics can be provided in determining the correct number of workstations. My recommendation to

improve work flow is to utilize assembling and balancing strategies in Shuzworld’s Shanghai Production

Facility (SSPF). Due to the circumstances surrounding this issue, I have chosen this decision analysis tool

because the goal of using a layout strategy is “to develop an effective and efficient layout that will meet the

firm’s competitive requirements” (JGT2 power point presentation). Proper job layouts must support a business's

competitive priorities: process, flexibility, customer contact, and quality of work life.

Although there are a variety of layouts to choose from, I recommend using the Product Oriented Layout

in order to maximize the long run efficiency of operations by achieving the following: Higher utilization of

space, equipment and people, improved flow of materials, information and people, improved employee morale

and safer working conditions, improved customer interaction, and more flexibility. The current budget

produces 6 workboots in one hour with a 40 hour work week making this the most appropriate layout for the

production of footwear as it allows for the relationship between our best personnel and machine utilization for

the repetitive and continuous production of our product.

I recommend that management organize this production process into 5 workstations with the appropriate

tasks in each workstation to produce the Rugged Wear Work boot.

I recommend that management organize this production process into 5 workstations with the appropriate tasks

in each workstation to produce the Rugged Wear Work boot.

Station # Task Time

1 A 10

2 B, C 9

3 D 8

4 E, F, G 10

5 H 9

The 5 workstation layouts would provide a maximum cycle time of 10 minutes or less per

Station # Task Time

1 A 10

D G

B&C

A H

E

F

2 B, C 9

3 D 8

4 E, F, G 10

5 H 9

The 5 workstation layouts would provide a maximum cycle time of 10 minutes or less per station with a

total time needed for each cycle of 46 minutes. Task A would start the cycle and take 10 minutes. Task B and C

would follow and consume 9 minutes. Task D would follow and take 8 minutes. Task E, F and G would begin

and take 10 minutes followed by the final step H and consume 9 minutes. Because workstations 2 and 4 contain

multiple production processes these employees should be cross trained in performing these tasks to help keep

the process moving and in fact over time could reduce the process time. This arrangement would be the most

efficient and provide the greatest cost savings to the company for the production of the Work boot. This

improved workflow achieved 100.00% efficiency with a 0% balance delay.

The assumptions for choosing this layout strategy include that there is enough volume for high

equipment utilization, product demand is stable enough to justify investment in specialized equipment, material

used to make product will work well with specialized equipment. Using this layout strategy will directly

improve workflow by minimizing the imbalance between machines and personnel while meeting the required

output. Additionally, assembly line will put fabricated parts together at a series of workstations to create a

smooth continuing flow on the assembly line with little idle time at each workstation. (Heizer, 2010). In order

to be able to produce at a specified rate, we must be aware of the tools, processes and equipment being used.

By inputting the information into the layout strategies method, I conclude that SSPF can eliminate 3 of

their workstations. Therefore, it will be 92% efficient with 50 minutes of time allocated, 4 minutes of idle time,

and 10 minutes of maximum cycle time.

A1) Justification

The learning curve was chosen because of the strategic importance that is placed on a learning curve.

The learning curve is applied to assist in the development of strategic decisions on levels of employment,

opportunities, costs and prices. Repeat the same results in less time on this operation. This means more time to

produce more because it takes less time to produce. Available resources and the process of change can also

change the learning curve, and that the company pursues the learning curve to get the cost savings should be

increased for the curve of volume exist. As the production time is reduced work hand amount less than when

started the production. As you can see in the analysis, it took hours to produce the first Sandals series 3737,741

5 and 6101.82 hours to produce only 4 times more expensive than the first batch of sandals. Cycle to work port

boot time is 10 minutes (480 minutes / day/48 units per day). Enter these data, as well as the calendar of

assembly Excel OM v4 gave the following results of heuristics for a long time.

The learning curve was chosen because of the strategic importance that is placed on a learning curve.

The learning curve is applied to assist in the development of strategic decisions on levels of employment,

opportunities, costs and prices. Repeat the same results in less time on this operation. This means more time to

produce more because it takes less time to produce. Available resources and the process of change can also

change the learning curve, and that the company pursues the learning curve to get the cost savings should be

increased for the curve of volume exist. As the production time is reduced work hand amount less than when

started the production. As you can see in the analysis, it took hours to produce the first Sandals series 3737,741

5 and 6101.82 hours to produce only 4 times more expensive than the first batch of sandals. Cycle to work port

boot time is 10 minutes (480 minutes / day/48 units per day). Enter these data, as well as the calendar of

Assembly Excel OM v4 gave the following results of heuristics for a long time.

A1a) Justification Output

We inputted the performance times for each task, A through H and the sequence requirements into an

assembly line balancing tool to perform an analysis to determine the proper number of stations and the most

efficient workflow possible. The analysis tool calculated that the number of workstations needed was 5.

Maximum station task time was 10 minutes and the time needed per cycle was 46 minutes. These calculations

gave this process an efficiency of 100.00%.

This decision tool was selected to help achieve a higher efficiency of production and a possible reduction

in production floor space. A properly balanced line will increase throughput and lower production costs

Results Summary

Cycle time 10

Time needed per cycle (S task times) 46

Min (theoretical) # of stations 5

Actual number of stations 5

   

Improved cycle time = Maximum station cycle time 10

Time allocated per cycle 50

Idle time per cycle 4

Efficiency 92.00%

Balance delay 8.00%

The five different workstations for the most efficient production are listed below.

Workstation 1: Task A

Workstation 2: Tasks B and C (with a 1 minute idle time)

Workstation 3: Task D (with a 2 minute idle time)

Workstation 4: Tasks E, F, and G

Workstation 5: Task H (with a 1 minute idle time)

Work In the Assembly line balancing module was the tool to use for this information. This tool minimizes

the number of workstations they are necessary and allows for maximum efficiency. This also ensures that all the

work is split about evenly between workstations. Also has had five different rules in the list and for each

calculation shows. heuristic algorithm for a long time was chosen because it puts the arduous task in first

preferences. Since it is the most long task in the manufacture of wear-resistant work boots, it is advisable to

start with. Then, the next workstation can begin with the next longest task with short assignments, filling gaps

in its case. each workstation with task sequence is being developed in an appropriate manner and time for tasks

is as close to the time of the cycle as possible.

This makes the efficiency of 92% of the Assembly line. Priority 1, long time operation was chosen to

help firms understand how the assembly line will be created. It considers all other heuristics, but they all have

the same efficiency. the assembly line in five stations be the most efficient way to produce his starting job from

wear resistant Shuzworld. This will allow the efficiency of 92%, with only 4 minutes of downtime on the

Assembly line.

A1ai) Work Flow Analysis Tool

Maui Sandals Shuzworld prepares to launch its new product, Maui sandals. Companies need to know

what hours of production should be covered during the first four months, and how much in direct labour costs

should be borne by the company predicts that the first batch of sandals take 1000 working hours to produce. The

company has a learning curve is 80%. Using the POM for Windows, this information can be connected to the

module of learning curves to determine how many hours of work each shipment will take to produce.

There will be 50 episodes in total: 5 for 1 month, 10 per month, 15 2 during 3 months and 20 month 4. 1

month sees the production of five parts. These packages will be taken more hours of production than others,

because the company is still at the beginning of the curve of learning-still are learning to effectively produce

Maui sandals.

These first five episodes will have 3737.741 hours. The company States that each hour of labor costs

$1.08, $4036.76 budget work requires that first month. month 2 plan the production in series 10. These

packages are non-6-15, within four months. Labour calculated for these series are 4772,7959 10, total

$5154.62.3 month plan labor cost increase production to 15 episodes. These packages are non-16 to 30, held for

four months. This results in a 5509.3561 working hours. Multiply $1.08, this number appears $5950.10.4

months of work occur 20batches of Maui sandals or batch number 31-50, four months ago.

Hours of work will be 6101.821, which would result a 6589.97 $ labor costs. the following table shows

what amounts to Shuzworld budget for the first four months of the project, Maui sandals.

Budget for Maui Sandal Project

Labor Hours Labor Costs

Month 1 3737.741 $4036.76

Month 2 4772.7959 $5154.62

Month 3 5509.3561 $5950.10

Month 4 6101.821 $6589.97

B ) Costs Analysis

In consideration of the impact of cost on the decision to continue producing the new line of Maui

Sandals, my recommendations are as follows: Based on the information provided, I recommend using a

learning curve tool due to the nature of the problem to be analyzed as the Learning curve tool is based on the

premise that people and the organization become better at their tasks as the tasks are repeated which ultimately

lowers production costs. Therefore the time it takes to produce a unit is reduced the more time units are

produced which decreases the rate of improvement overtime. The Learning Curve tool is both an excellent

internal and external tool used to engage in strategic planning. In our scenario, learning curves (unit times) are

the most helpful to be able to manufacture and to determine whether or not to continue producing new product

lines.

I have determined that the Maui sandal 4 month production run will take a total of 20126.97423 labor

hours and cost 20,121.71 at the labor rate of $1.08 per hour. Month 1 will require 3737.741 labor hours at a cost

of $4,036.76. Month 2 will require 4775.66988 labor hours at a cost of $5,154.62. Month 3 will require

5511.74336 labor hours at a cost of $5,950.10 and month 4 will require 6101.82 labor hours at a cost of

$6,589.97. As you can see the hours required for the production of sandals decrease as more sandals are

produced. By continuing to produce this line your total labor costs will continue to decrease but at a slower rate

as more sandals are produced. This information will help the company determine employment levels, capacity,

costs and their pricing of this product in the marketplace.

The learning curve decision tool was selected because of the strategic importance that is placed on the

learning curve. The learning curve is applied to aid in the formulation of strategic decisions about employment

levels, capacity, costs and pricing. Repetition of the same operation results in less time expanded on that

operation. This means there is more time to produce more products because it takes less time to produce. The

available resources and process changes may also alter the learning curve and as the company pursues the

learning curve to achieve cost savings volume must increase for the curve to exist.

B1) Impact

To produce the new Maui Sandal line, the initial costs include (1000x5)*1.08 = $5400 in month one. In

month four, with 50 batches of Maui Sandals, SSPF would need 10484.94 x 1.08 = $11,323.73. Given this

data, SSPF can use this information to plan for labor costs, schedules, and cost and budget forecasting.

Additionally, SSPF could use it strategically such as using the information to evaluate company and industry

performance in terms of costs and pricing.

As indicated in section B, as production time goes on, the amount of labor decrease is smaller than when

production first started. As you can see from the analysis it took 3737.741 labor hours to produce the first 5

batches of sandals and only 6101.82 labor hours to produce 4 times as many sandals as the first batch.

Therefore, it makes sense to recommend the continuation of producing the new sandal line incorporating the

following guidelines:

Follow an aggressive pricing policy. Focus on continued cost reduction and productivity improvements. Build a shared experience. Grow capacity ahead of demand.

Although costs may decline by using the learning curve methodology, it is important to acknowledge from

this data that volume must be increasing in order for the learning curve to manifest itself. With that it mind,

Shuzworld understands its competitors and knows that its weaker competitors are undercapitalized, stuck with

high costs, and do not understand the value of learning curves, to add further impact on continuing the line.

Shuzworld also has the confidence, establishment and momentum to stand up to their stronger competitors in

terms of controlling costs, and a stronger financial position as a result.

Impact on Labor Costs and the Decision to Continue or Discontinue the Sandal Line:

The company is predicting that the first batch of sandals will take 1,000 labor hours to produce. The

company has a learning curve of 80%. Using POM for Windows, this information can be plugged into the

learning curves module to determine how many hours of labor each batch will take to produce. There will be

50 batches total: 5 for Month 1, 10 for Month 2, 15 for Month 3, and 20 for Month 4.

Month 1 sees production of five batches. These batches are going to take more production hours than

the others, because the company is still at the beginning of the learning curve- they are still learning how

to efficiently produce the Maui Sandal. These first five batches will take 3737.741 hours. The company states t

hat each labor hour costs $1.08, which results in a $4036.76 labor budget required that first month.

Month 2 expects to have 10 batches produced. These batches will be numbers 6 through 15 produced

over the course of four months. The calculated labor hours for these 10 batches are 4772.7959, for a total labor

cost of $5154.62.

Month 3 expects to increase production to 15 batches. These batches will be numbers 16 through 30

produced over the course of the four months. This results in 5509.3561 labor hours. Multiplying this number by

$1.08 shows labor costs of $5950.10.

Lastly, Month 4 will produce 20 batches of the Maui Sandal, or batch numbers 31-50 produced over the

course of the four months. The labor hours will be 6101.821, which will result in $6589.97 of labor costs.

The following table shows what amounts Shuzworld should budget for the first four months of the Maui

Sandal Project.

Budget for Maui Sandal Project

Labor Hours Labor Costs

Month 1 3737.741 $4036.76

Month 2 4772.7959 $5154.62

Month 3 5509.3561 $5950.10

Month 4 6101.821 $6589.97

The very first batch of sandals that Shuzworld is going to produce will take 1,000 labor hours. It might

pleasantly surprise the company to know that due to the learning curve, the 50th batch will only take 283.8271

hours, thus greatly reducing the labor costs associated with each batch. Although the company will not see the

drastic decline in labor hours that they saw at the beginning of the project, the labor hours will continue to

decrease in future months.

Due to the fact that the company will continue to see the decreased labor costs, Shuzworld should

continue their line of Maui Sandals past the first four months. They will be operating with increased

efficiency, which will allow for more profits on each batch of sandals. The company states that they are

expecting a great demand for this product, which led to their decision to have an aggressive roll-out of the

sandals. If they were to discontinue the Maui Sandal and begin production on another shoe, they would have to

start back at the beginning of the learning curve, thus increasing labor hours. Shuzworld should take advantage

of the product demand and lower labor costs to make more profit on the Maui Sandal.

The Learning Curves module in POM for Windows was used to calculate this information, with the

option of finding times given a coefficient. This was the tool chosen, because it accurately calculates the

information needed, based on the given coefficient of 80%.

B2 ) Cost Analysis Output

The learning curve is based on the doubling of production. For example, when production doubles, the

decrease in time per unit affects the rate of the learning curve. If the learning curve is at an 80% rate, then the

second unit takes 80% of the time of the first unit, the fourth unit takes 80% of the time of the second unit, the

eighth unit takes 80% of the time of fourth unit and so on up to all 50 units. Therefore, the Learning Curves

module in POM for Windows was used to calculate this information, with the option of finding times given a

coefficient. This was the tool chosen, because it accurately calculates the information needed, based on the

given coefficient of 80%.

The company is predicting that the first batch of sandals will take 1,000 labor hours to produce. The

company has a learning curve of 80%. Using POM for Windows, this information can be plugged into the

learning curves module to determine how many hours of labor each batch will take to produce. There will be

50 batches total: 5 for Month 1, 10 for Month 2, 15 for Month 3, and 20 for Month 4.

Output:

 Unit number Time

First 1 3737.741Last 4 6101.82

Results

b0.3535365

1Learning curve 1.2776888

coefficient 2Time for first unit 3737.741

Unit TimeCumulative time

Unit 1 3737.741 3737.741

Unit 2 4772.79598513.4108

79

Unit 3 5509.356114025.154

23

Unit 4 6101.82120126.974

23

1 2 3 40

1000

2000

3000

4000

5000

6000

7000

Learning Curve

Unit

Tim

e

B2a) Cost Analysis Tool

I recommended using the learning curve tool as it provides a mathematical relationship between the time

it takes to produce a specific unit. This relationship is a function of how many units have been produced before

the unit in question, and how long it takes to produce them. Because this is based on a scientific approach, we

are able to forecast a variety of scenarios using mathematical analysis, logarithmic analysis, and learning curve

co-efficient and make a solid decision on whether or not to continue the sandal line. For example, using a

mathematical approach, it is evident from the chart provided in section B2, that each time production doubles,

labor costs per unit decrease by a constant factor known as the learning rate.

I also recommended the learning curve tool for strategic reasons. Not only have I demonstrated that

managers can use this tool in forecasting labor hour requirements, but it can also be used in determining a

supplier’s cost which is valuable information to have when negotiating pricing. However, it is essential that

managers understand our competitors before applying the learning curve strategy.

A. Staffing Plan Recommendation

It is my feeling, based on the data, that our efforts should focus on minimizing completion times,

maximizing the utilization of our facility, while minimizing Work In Process (WIP), as well as keep customer

waiting time down to a minimum. My recommendation is to use short-term scheduling, or the “assignment

method”, as the staffing plan going forward. (Heizer 2010) By taking this approach to a staffing plan, it will

address the timing of operations, allocation, and prioritization that SSPF is currently struggling with. In

summary, the objective in using short term scheduling is to maximize the use of resources to allow the company

to meet its production objectives.

C1 ) Staffing Plan Output

As outlined below, the total cost is projected to be $37 given that SSPF assigns jobs to machines per the

following:

Job Assigned to Cost

Job 1- Machine A 10

Job 2- Machine B 9

Job 3- Machine D 9

Job 4- Machine C 9

Total 37

My recommendations include shifting operators around as I believe it is most efficient way for SSPF to

save in the production of these jobs.

C1a) Staffing Plan Analysis Tool

The above assignments are my recommendation for loading jobs to ensure that costs, idle times and

completion times are all kept to a minimum. This is achieved by assigning specific jobs to specific machines

using the assignment tool. The assignment tool was selected to perform a cost effectiveness analysis for the 4

machines and the 4 jobs because it will determine which machine would perform which job and provide the

lowest cost to the company. By performing this analysis on each job or machine the company will be able to

minimize costs and the time to perform the job.

The assignment tool was selected to perform a cost effectiveness analysis for the 4 machines and the 4

jobs because it will determine which machine would perform which job and provide the lowest cost to the

company. By performing this analysis on each job or machine the company will be able to minimize costs and

the time to perform the job.

The assignment tool will effectively manage facility work flows that were addressed in previous sections of

this memo. Using the Input/ Output methodology, our work can more effectively be tracked to more effectively

monitor work flows. It will help to avoid overloading and crowding of the facility leading to inefficiencies and

quality problems as well as under loading which leads to idle capacity and wasted resources.

B. Outline

Good scheduling means lower costs and faster more dependable delivery and plays a major role in satisfying

customers. Effective scheduling means faster movement and goods and services through our facilities, added

capacity and faster delivery, as well as dependable delivery based on realistic commitments. (Heizer, 2010).

Based on the aforementioned short-term scheduling techniques is a way to stream line our transportation

process and improve efficiencies in this area. As I have outlined below, to achieve these efficiencies SSPF will

need to pay $7 to move its units through the production system.

JOB Assigned to Cost

Job 1 Machine 2 3

Job 2 Machine 3 2

Job 3 Machine 1 2

Total 7

Short Term Scheduling

Effectiveness means faster movement of goods through the facility and faster delivery. This equates to lower costs for the company.

Scheduling Issues

Capacity plans

Are usually done on annual or quarter basis as equipment or facilities are purchased

or discarded

Aggregate planning

Makes decisions regarding subcontractors, people, facilities, equipment and inventory

Master schedule

Breaks down aggregate schedule and makes weekly schedule for specific product lines

or products

Forward and Backward Scheduling

Forward scheduling starts schedule when job requirements are known

Backward scheduling begins with the due date and schedules the last operation first

Scheduling Criteria

Minimum completion time

Evaluation determines the average completion time of each job

Maximum utilization

Evaluation determines utilization percentage of facility

Minimum work in process inventory

Evaluation determines average number of jobs in system.

Minimum customer wait time

Evaluation is based on determination of average number of late days

Schedule Process Focused Facilities

Schedule incoming orders without violating capacity constraints of individual work centers

Check tool and materials availability before releasing orders to various departments

Estimate due dates and check progress against finish dates and order lead times

Check work in progress as it progresses through the shop

Provide feedback on production and facility activities to improve overall process

Provide work efficiency status and monitor operator times

Loading Jobs

This is the assigning of jobs to the processing center

Input – Output Control

Manage facility work flows

This allows tracking of completed work and work that is added to the system

Options available to personnel to manage facilities are

Correct performance deficiencies

Increase capacity in the process

Increase or reduce input to work centers to meet capacity constraints

Gantt Charts

Shows loading and idle times of departments, machines or facilities

Major limitations do not account for production variability. Must be updated regularly

Assignment Method

Each assignment problem uses a table that contains the costs or times associated with that

assignment and the expected costs of that assignment. This method adds and subtracts

appropriate numbers to find the lowest opportunity cost for each assignment.

Assign tasks or jobs to resources to minimize total costs and performance time

Assignment problem is that1 job or worker is assigned to 1 machine

Sequencing Jobs

This technique assigns jobs to work centers and in what order they should be completed.

Priority rules for dispatching jobs

These guidelines are used to prioritize the sequencing of how the jobs should be worked

FCFS: first come first served

This is not the most advantageous of criteria, but it appears fairer to customers in a service

type system

SPT: short processing time

This minimizes work flow and orders in the system

EDD: earliest due date

This technique minimizes the maximum tardiness for jobs that include a harsh penalty if

the job is not completed by a certain due date

LPT: longest processing time

This is generally the largest jobs that will take the most amount of time. They are

scheduled first

Critical Ratio

This is an index number that is calculated by dividing the remaining time until the due date

by the remaining work time. This ratio can be updated easily and performs better than the

four priority rules mentioned earlier.

This ratio will help:

Determine the status of a specific job

Establish common basis jobs priority

Automatically adjust priorities for demand and job progress

Track job progress dynamically

Johnson’s rule

“Johnson’s rule can be used when there is more than one work center. Johnson’s rule minimizes processing and idle times with four steps that assign the jobs to a machine based on shortest time. First, all jobs and jobs times are written down and assigned to a machine. Then the job with the shortest time is selected. If that job is assigned to the first machine, it is scheduled first. If that job happens to be assigned to the second machine, it is scheduled last. Then that job is removed from the list, and the steps are repeated, until there are no more unscheduled jobs. This ensures that all jobs are scheduled, with the least amount of idle time possible (Heizer & Render, 2010).”

This is an approach that will help reduce the processing time for sequencing a group of jobs across two

work hubs while reducing total down time in the work hubs.

Limitations of rule-based dispatching system techniques. All of these techniques are rule based and they

all have limitations. Rules need to be revised and adjusted to change in orders, equipment, product mix and

process. Rules do not look up or down the production process so idle resources or bottlenecks may not be

known in other departments. Rules do not look beyond due dates. Two orders can have the same due date but a

different priority status.

Finite Capacity Scheduling (Also called short term scheduling), provides scheduler with interactive

computing and graphic output and overcomes disadvantages of rule-based systems.

References

Heizer, J., & Render, B. (2010). Operations management. New Jersey: Pearson.

Do Not Forget to Submit Output Data that is part of download

Decision Analysis

Task 2A. Develop a distribution pattern that meets availability and demand

constraints and minimizes total shipping costs for Shuzworld, utilizing the appropriate decision analysis tool.

Shuzworld’s purpose is to increase its production in Shanghai from 1300 units to 2800

units. Although at present there is no increase in demand, they want to remain flexible in order to

ensure future growth. If this proves to be profitable, they want to be able to change their

transportation schedule. This is my recommendation to use the minimum monthly cost of

transportation and delivery plan to achieve this goal.

Another pressing challenge is the fact that the plant was the first object of Shanghai

Shuzworld in China, but they also have two other plants in Hangzhou, Fuzhou: Shuzworld H and

Shuzworld F. One of their main lines of women's shoes made in all three plants. In turn, the

shoes are sent Shuzworld three central warehouses for distribution to regional warehouses, and

then in the offline retail stores and shopping center.

Below, in the first graph shows monthly production capacity Shuzworld these shoes at

each of its plants and their monthly requirements to meet the demand at each of its stores.

Currently Shuzworld produces normal capacity at all three plants to meet current demand.

To increasing local production of Shanghai, Wu Alistair focused on the cost of transportation to

the warehouse Shuzworld F 3 and shipping costs, which amounted to $ 6 per unit shipped. Please

see the table below to analyze the data. The total cost of shipping was originally $ 13,600

Factory Capacity

Warehouse Requirements

Shanghai 1300 1 2500Shuzworld H 2300 2 1500Shuzworld F 2200 3 1800Totals 5800 6 5800

The table below reflects the fact that it costs us to provide the unit. For example, the more

expensive route Shuzworld send Warehouse Shuzworld F 3 for the price of $ 6 per unit

shipped.

.

To/From

Warehouse 1 Warehouse 2 Warehouse 3

Shanghai $4 $3 $3Shuzworld H $3 $4 $2Shuzworld F $2 $4 $6

Using data provided by the managers at Shuzworld, I built a matrix less transportation

summarizing the data collected to develop a picture of the distribution, which corresponds to the

availability and demand constraints and minimizes the total cost of delivery.

From /To Warehouse 1 Warehouse 2 Warehouse 3 Factory Capacity

Shanghai $4 $3 $3 2500

Shuzworld H $3 $4 $2 1500

Shuzworld F $2 $4 $6 1800

Warehouse

Requiremen

t

1300 2300 2200 5800

I have been tasked to determine the lowest possible monthly cost of transport by shipping

plan; Accommodate the plants in Shanghai increased from 1,300 to 2,800. I recommend using

the analysis tool of transportation to find the lower costs associated with the request. To enable

better and cheaper shipping methods, we had to add a fourth destination (virtual storage) to see

how effective the supply and demand will be while decreasing the total cost of the mission. The

following diagram describes the new shipping cost by increasing production in Shanghai from

1,300 to 2,800 units. You will find that with the addition of the fourth destination costs decreased

by $ 200 to save the company a lot of money but little. The new total cost for the company is $

13.400.

Shipments|Dest 1|Dest 2|Dest 3|Dest 4|Total|

Origin 1 |0 |1500 |0 |1300 |2800|Origin 2 |300 |0 |1800 |200 |2300|Origin 3 |2200 |0 |0 |0 |2200|

Total |2500 |1500 |1800|1500|7300 \ 7300|

Total Cost| $13,400

Please note that when supply is greater than aggregate demand we demand exactly equal to the

creation of a virtual destination and when the demand is greater than the aggregate supply, we present a

virtual source with flow equal to the excess of demand. The data transfer model was the best way to

reach a valid conclusion Wu for providing the lowest possible monthly cost of transportation. This will

analysis tool will save the company $ 200 in shipping costs.

A1/A1a.  Submit a copy of the output from your decision analysis tool of choice.

a. Explain why you chose the decision analysis tool you used.

In my consultation with executive members of Shuzworld, I gained an understanding of the goals to increase

production, with flexibility for future growth. I recommend the Stepping Stone Method. I chose this decision analysis tool . I

chose this decision analysis tool, because it meets the business objectives and allows you to adjust over time to accommodate

the flexibility they desire. In addition, the intuitive and the north-west corner of the method does not always improve

performance and minimal cost and are used only as a starting point, and step method will allow the initial solutions and work

towards a more optimal. Using this method will also help to assess the effectiveness of the cost of shipping goods on routes

that are not currently in use, in order to better flexibility.

Using this tool, I calculated the index below to improve Shanghai - Warehouse 2 by way of value added per unit area with the

ins and subtracting the cost of a square with a minus.

Using this tool I have computed the below improvement index for the Shanghai – Warehouse 2 route by adding unit costs in squares with plus signs, and subtracting costs in squares with minus signs.

Shanghai – Warehouse 2 index: $3 - $4 +$3 - $4 = $-2

From /To Warehouse 1 Warehouse 2 Warehouse 3 Factory Capacity

Shanghai $4 - $3 Start $3 - 2500

Shuzworld H $3 + $4 - $2 + 1500

Shuzworld F $2 Start - $4 + $6 - 1800

Warehouse

Requiremen

t

1300 2300 2200 5800

This translates, for every unit shipped via Shanghai - Warehouse 2 route will reduce our total cost of transportation by $ 2.00.

From /To Warehouse 1 Warehouse 2 Warehouse 3 Factory Capacity

Shanghai $4 - $3 + $3 - 2500

Shuzworld H $3 + $4 - $2 + 1500

Shuzworld F $2 Start - $4 + $6 - 1800

Warehouse

Requiremen

t

1300 2300 2200 5800

Shuzworld F – Warehouse 3 index: $2 + 4 - $6 +$2 - $3 + $3 - $4 + $3 = $1

The Shuzworld F –Warehouse 3 route will result in an increase in total transportation costs by $1.

This stepping stone method, therefore serves as an effective procedure for solving problems that involve minimizing the cost of shipping products from a series of sources to a series of destinations. As we saw in the first example, there are cost saving opportunities using this method considering one of the major lines of women’s shoes is produced in all three plants. This can be consolidated to one or two plants in an effort to streamline and reduce production costs.

It is therefore determined that by using this tool what shipping routes will allow the maximum number of units at the lowest cost. The tool can be used to conduct ongoing tests in order to determine whether or not the solution is optimal or whether or not improvements can still be found. (Heizer & Render, 2010, p. 718).

 

B. Analyze the reliability of the computer-driven shoe machines process in the Shuzworld Shanghai plant.

Addressing the concern regarding the reliability of the three machine used to make deck shoes, it is imperative to plan around the possibility of one of the three machines failing. This means the shoes cannot be finished until either the failed machine is replaced or repaired. Handel would like to know their current system reliability and wish to improve upon, and which machine can be used for a back-up. Current reliability of the three machines, 76%, is in the chart below.

Deck shoes reliability

Machine ReliabilityNumber One .84Number Two .91

Number Three .99

Using the reliability analysis tool I was able to find the current reliability (76%) and the new reliability (88%) for the company. If one of the machines should malfunction, machine one would be the appropriate choice for a back up. The chances of machine one breaking down is far less possible than the other two machines. Reliability is the probability that a machine will function properly for a specified time (Heizer, J. and Render, B. 2010). I recommend the following things to keep the machines up and running with the best possible efficiency: regular/preventative maintenance and well-trained personnel. Implementing these strategies will not only help the longevity of the machines but will save the company money on repairs in the long run.

I believe that the reliability analysis tool was the best tool to use to find a reliable backup for the malfunctioning machine. With use of this tool Shuzworld machine reliability increased by 12% and became less of an issue for the company.

B1/B2. Recommend ways to increase the reliability of the system, utilizing the appropriate decision analysis tool.

Maintenance of the machines is a direct link to their reliability and should involve good procedures as well as employee involvement. Employee involvement should consist of a combination of partnering with maintenance personnel, skill training, a reward system, and employee empowerment. (Heizer, 2010).

The maintenance activities that affect reliability and that should be incorporated into the procedures include cleaning and lubricating the machines, monitoring, adjusting, and making minor repairs, as well as maintaining good records of the maintenance provided.

If these activities are incorporated into routine procedures the results will include reduced inventory, improved quality & capacity, a reputation for quality, continuous improvement, and reduced variability.

All of this can be achieved by using the decision analysis tool of Reliability Analysis. Since the existing machines have a high level of reliability, it makes sense to perform routine inspections and service of machines to keep the running well. Preventative Maintenance requires a combination of both technical and human systems to keep the productive processes performing within tolerance.

Machine failures will occur, but the point of performing preventative maintenance it to know the likelihood of WHEN the machine will fail and know when it needs service and maintenance to avoid failure. Machines will often fail simply due to misuse by the operator which is why the training and involvement of employees is critical.

Since the existing machines at Shuzworld are established with a high reliability rate, it is essential to start conducting MTBF (Mean Time Between Failures) on the existing machines. Performing these studies will allow us to see deviation patterns that will alert us as to which machine(s) require maintenance. From there we must determine which maintenance plan is the most economical taking into consideration that what might appear to be a minor breakdown but can have devastating consequences.

B2a.  Submit a copy of the output from your decision analysis tool of choice.

a.  Explain why you chose the decision analysis tool you used

I believe that the reliability analysis tool was the best tool to use to find a reliable backup for the malfunctioning machine. With use of this tool Shuzworld machine reliability increased by 12% and became less of an issue for the company.

Reliability Data

|Series 1|Series 2|Series 3|

Component|0.84| |0.91| |0.99|

Backup 1|0.84|0|0|

Results

|Series 1|Series 2|Series 3|

Component|0.16| |0.09| |0.01|

Backup 1|0.16|1|1|

Reliability|0.9744|0.91|0.99|

Sys Reliability|87.79%|

 

C. Provide the optimum number of shoelaces to order for the Shuzworld Factory, considering appropriate cost balancing, utilizing the appropriate decision analysis tool.The objective of inventory management is to strike a balance between inventory investment and customer service. You can never achieve a low-cost strategy without good inventory management. There are several functions of inventory that add flexibility to a company’s operations and they are: To decouple or separate various parts of the production process, To decouple the firm fluctuations in demand and provide a stock of goods that will provide a selection for customers, to take advantage of quantity discounts, and to hedge against inflation and upward price change. These are some to the things Angela and her staff will need to implement to better manage their inventory (Heizer, J. and render, B. 2010).

Angela and her staff are looking for ways to optimize the number of units to order at a time. I recommend that Angela and her team use the Economic Order Quantity (EOQ) Model analysis tool to find the optimal number of units to order at a time. This is one of the most commonly inventory-control techniques used. To get the optimal number of units to order at a time please view my findings below.

C1. Explain how an economic order quantity amount relates to the problem.

The economic order quantity amount relates to this problem in that it minimizes the total ordering and holding cost for the company. In the problem we were able to help minimize the cost of shoelaces by finding the optimal number to order while saving/balancing the cost to Shuzworld. Now Angela and her team will be able to better manage their cost and ordering.

C2.  Submit a copy of the output from your decision analysis tool of choice.

a.  Explain why you chose the decision analysis tool you used.

I chose to use the Economic Order Quality (EOQ) analysis tool because it provided the data needed to find Angela’s team ways to optimize the number of units to order at a

time. The method also helped her balance the cost of shoelaces by ordering as needed. The EOQ solved Angela’s problem by minimizing the total order and holding cost for the company.

Data

Demand rate, D|300000|

Ordering/Setup cost, S|125

Holding cost, H|0.1|(fixed amount)|

Unit Price, P

Results

Optimal Order Quantity, Q*|27386.12788|

Maximum Inventory|27386.12788|

Average Inventory|13693.06394|

Number of Orders|10.95445115|

Holding cost|$1,369.31|

Order cost|$1,369.31

Unit costs|$0.00

Total cost, Tc|$2,738.61

COST TABLE|Start at|3423.266|Increment by|1141.089|

|Q|Setup/Order cost|Holding cost|Total cost|

|3423.265984|10954.45|171.1633|11125.61|

|4564.354646|8215.838|228.2177|8444.056|

|5705.443307|6572.671|285.2722|6857.943|

|6846.531969|5477.226|342.3266|5819.552|

|7987.62063|4694.765|399.381|5094.146|

|9128.709292|4107.919|456.4355|4564.355|

|10269.79795|3651.484|513.4899|4164.974|

|11410.88661|3286.335|570.5443|3856.88|

|12551.97528|2987.578|627.5988|3615.176|

|13693.06394|2738.613|684.6532|3423.266|

|14834.1526|2527.95|741.7076|3269.658|

|15975.24126|2347.382|798.7621|3146.144|

|17116.32992|2190.89|855.8165|3046.707|

|18257.41858|2053.96|912.8709|2966.831|

|19398.50724|1933.138|969.9254|2903.064|

|20539.59591|1825.742|1026.98|2852.722|

|21680.68457|1729.65|1084.034|2813.684|

|22821.77323|1643.168|1141.089|2784.256|

|23962.86189|1564.922|1198.143|2763.065|

|25103.95055|1493.789|1255.198|2748.986|

|26245.03921|1428.841|1312.252|2741.093|

|27386.12788|1369.306|1369.306|2738.613|

|28527.21654|1314.534|1426.361|2740.895|

|29668.3052|1263.975|1483.415|2747.39|

 

D. Compare the characteristics (e.g., number of customers waiting, waiting time, total checkout time) of one-cashier and two-cashier waiting-line systems.

Cynthia Crowninshield has asked for recommendations and analysis of the customer service procedures. Using the M/M/1 and M/M/2 decision analysis tool for waiting lines I was able to find what Ms. Crowninshield needed in reference to a single server (one cashier). Please view

the diagram below and you will find that when single server tool (M/M/1) is used the arrival rate is 6, service rate is 12, and the number of servers are 1. In the second diagram I was able to use the M/M2 to compare the characteristics and found that the arrival rate is 6, service rate 12, and the number of servers is 2. Characteristics of the waiting line system are: arrival, waiting-line, service and performance. These four measurements were taken into consideration when deciding to staff the store properly.

1.

D1. Recommend a one-cashier or two-cashier waiting line system, utilizing the appropriate decision analysis tool.

One cashier would be sufficient for Shuzworld because with the arrival rate and service rate given in both equations, there is not a sufficient enough difference to employ two full-time cashiers.

When comparing the characteristics my analysis, I found that if the company employs one cashier the average number of customers queue would be 0.5, average wait time would be 0.08333, and the total checkout time would be 0.5. On the other hand, considering employing two cashiers, the average number of customers in queue would be 0.0333, average wait time would be 0.0056, and the total checkout time would be 0.6. After reviewing my finding and giving days of thought to the results of the decision analysis tool, I recommend employing one cashier as Mrs. Crownshield suggested.

D2. Submit a copy of the output from your decision analysis tool of choice.

a.  Explain why you chose the decision analysis tool you used.

 

Waiting Lines M/M/1 (Single Server Model)

Data Results

Arrival rate ()|6||Average server utilization()|0.5||

Service rate ()|12|Average number of customers in the queue(Lq)|0.5|

Number of servers|1Average number of customers in the system(Ls)|1|

Server cost $/time)| Average waiting time in the queue(Wq)|0.08333|

Waiting cost ($/time)| Average time in the system(Ws)|0.16667|

|Probability (% of time) system is empty (P0)|0.5|

|Cost - based on waiting|0||

|Cost - based on system|0||

The diagram below displays the same data as above but with 2 servers using the M/M/s analysis tool, which allows for multiple servers.

Waiting Lines M/M/s

Data Results

Arrival rate ()|6||Average server utilization|0.25|

Service rate ()|12||Average number of customers in the queue(Lq)|0.0333|

Number of servers(s)|2||Average number of customers in the system(Ls)|0.5333|

Server cost $/time)| Average waiting time in the queue(Wq)|0.0056|

Waiting cost ($/time)| Average time in the system(Ws)|0.0889|

|Probability (% of time) system is empty (P0)|0.6|

|Cost - based on waiting|0|

|Cost - based on system|0|

In scenario four, I chose to use the waiting line analysis tool because it supplied accurate information for making the decision of employing one/two full time cashiers for Shuzworld. Using this queuing system I found that single line performance was efficient enough.

References:

Heizer, J. & render, B. (2010). Operations Management (10th Ed). New Jersey: Pearson.

Decision Analysis

Task 3

MEMO

Robert Hixon

Consultant

A. Recommend which method (i.e., using reconditioned equipment, purchasing new equipment in its Shanghai plant, or outsourcing to another manufacturing operation) Shuzworld should use for the manufacturing of its sneakers, utilizing the appropriate decision analysis tool.

Shuzworld has decided to produce the Samba Sneaker, a bright colored shoe marketed for

teens and pre-teens. The company needs to decide which would be more economical:

reconditioning their existing equipment for this production, buying new equipment, or

outsourcing the production to China. Reconditioning has a fixed cost of $50,000 and a

variable cost of $1,000 for every 1,000 sneakers produced. Purchasing new equipment

has a fixed cost of $200,000 and a variable cost of $500 for every 1,000 sneakers.

Outsourcing production to China has no fixed costs, and variable costs of $3,000 for

every 1,000 sneakers produced.

I have reviewed the figures and have made a recommendation based on my findings. It is

my determination that given the data, we should recondition. The data below reflects the

outcome of reconditioning old equipment, purchasing new equipment, and outsourcing.

Below is an insert from POM for Windows an operations management tool used to

determine best decisions in business operations.

Inputting this data into POM for Windows gives the following results:

There are two types of costs to consider, fixed and variable. Based upon the information

given the relationship between cost and revenues are linear. In order to use the cost

volume and breakeven analysis tool, variable costs must be constant. Here we have

constant costs but different scenarios which qualify it to be used by this tool. Using this

tool, I created inputs for reconditioning new equipment, buying new equipment, and

outsourcing. The figures for fixed and variable costs were used from company research.

It was determined that at 1,000 units the variable costs could be determined and that it

would be a good place to set our volume for analysis. The total fixed costs for

reconditioning is $50,000 with one million dollars spent in variable costs for a total cost

of $1.5 million. To purchase new equipment, the fixed costs are $200,000 and the

variable costs are half of the cost of reconditioning the old equipment at $500,000 for a

total cost of $700,000. Finally, to outsource, while there would be no initial or fixed

costs, the variable cost would be $3 million, twice as much as it would costs to

recondition the old equipment and 4 times as much as simply buying new equipment.

According to the data presented to me, Shuzworld will save the most money by buying

new equipment. While the fixed costs are more, the variable costs don’t compare to that

of reconditioning or outsourcing. Below is a copy of the crossover chart showing where

each one has its financial advantage over the other.

VOLUME RANGES: The volume (in units) range for each

manufacturing option are as follows as shown in the crossover chart above:

The breakeven volume for reconditioning vs. outsourcing is 25 units,

The volume increases to 80 units under the purchase vs. outsourcing option

The recondition vs. purchase option shows a volume of 300 units.

When looking at the point of breakeven, the breakeven in reconstructing vs

buy is at 300 units and a cost of $350,000. Recondition vs outsource brings us

to a breakeven of 25 units and $75,000. Buy new vs. outsource gives us a

breakeven of 80 units for a cost of $240,000. Recondition vs. buy gives us the

lowest breakeven point which means that we start making profit at 300 units.

The crossover chart tells us at which point we should switch to something

else. Based on these figures, it would appear we will save the largest amount

of money if we buy new equipment, even though the fixed costs will be higher

initially, the variable costs are considerably lower than reconditioning or

outsourcing. The crossover chart above shows the points at which each

option presents a financial advantage over the other.

According to the calculations:

It will cost a total of $1.5 million dollars to recondition the equipment ($50,000/ fixed and $1 million/variable).

Purchasing new equipment will cost $700,000 ($200,000/fixed and $500,000/variable). This is half of what it would cost to recondition old equipment.

Outsourcing will cost $3 million ($0/fixed and $3 million/variable), which is twice the amount of reconditioning the old equipment and 4 times the amount of making a new purchase.

These calculations can now be used to determine the breakeven volume for Shuzworld’s options. The data above states that the breakeven volume for reconditioning versus buying new equipment is 300 units. The breakeven volume for reconditioning versus outsourcing is 25 units, and the breakeven volume for buying new equipment versus outsourcing is 80 units.

Looking at the graph, it becomes apparent that if the demand for Samba Sneakers is between zero and 25 units, that outsourcing would be the best option. If the demand is between 25-300 units, reconditioning the equipment becomes the optimal choice. Buying new equipment becomes the best choice if the company has a demand over 300 units.

This means that the best option for the company will be determined by their demand. The company has given no indication of the amount of demand they expect to see, so a “best guess” scenario will have to be applied. It is unlikely that they will see a very low demand (less than 25 units), because the Samba Sneaker is an exciting new product. It is quite likely that the company will see a demand of 25-300 units.

Further points to recommend reconditioning would be that the operating director of the plant, Alistair Wu, does not like outsourcing. The company states that he is very particular about any production that is not in-house. Also, buying new equipment for this new product would be unwise, as it is unsure how it will perform in the future market of consumers as well as the project only planned for one quarter.

The numerical data and points taken from the case study all point towards the optimal choice to be reconditioning the existing equipment.

This data was calculated using POM for Windows. The Breakeven/Cost-Volume Analysis module was used because it had the option for the cost-volume analysis. This was appropriate because there was no given data for revenue or sales projections. The cost-volume analysis needed only the fixed and variable costs, and the volumes associated with those costs.

I chose the decision analysis tool breakeven cost volume analysis because the tool

allowed for ease of use and also had parameters set up to account for the different types

of costs and the number of options. In this case, we had 2 costs, fixed and variable, and 3

different options, reconstructing old equipment, purchasing new equipment, and

outsourcing. This decision analysis tool allowed me to construct a crossover chart which

showed the points at which the costs of the options demonstrated an advantage over the

other.

A1. Submit a copy of the output from your decision analysis tool of choice.

a. Explain why you chose the decision analysis tool you used.

The decision analysis tool I chose to solve this specific issue was the breakeven cost volume

analysis tool, because it was easy to use and had specific parameters already in place to account

for each type of cost and the number of options available. Since there are two costs (fixed and

variable) and three different options (reconstructing, purchasing, or outsourcing), the decision

analysis tool allowed me to graph a crossover chart that detailed the points at which the cost of

each option became advantageous over the other.

A review of the breakeven analysis shows that the breakeven points for each option are as

follows:

Option Breakeven Point Cost

Recondition vs. Outsource 25 units $75,000

Purchase vs. Outsource 80 units $240,000

Recondition vs. Purchase 300 units $350,000

The lowest breakeven point at which we start to earn a profit is at 350 units for the Recondition

vs. Purchase option and the crossover chart above shows us at which breakeven point each

option becomes more viable.

In addition to the recommendation above, the volume (in units) range for each manufacturing

option are as follows (see chart above): The breakeven volume for reconditioning vs. outsourcing

is 25 units, the volume increases to 80 units under the purchase vs. outsourcing option, while the

recondition vs. purchase option shows a volume of 350 units. Since we are attempting to save

money on this project the best option would be to purchase new equipment because, it is highly

likely that the demand for the new item will exceed 80 units, outsourcing is frowned upon by the

plant's Operating Director, and the quality of the product will be more easily managed by in-

house production. It is also fair to say that, if demand exceeds 80 units, then it would obviously

surpass the 25 unit demand mark, rendering both outsourcing and reconditioning useless and a

waste of company funds that can best serve the company in other investments. Furthermore,

implementing the product focused operation strategy which I used to assist me in making the best

possible decision, proved that a high fixed cost and low variable cost combination is the most beneficial

option to select. Using the product focused operation strategy allowed me to a specific standard and

maintain a specific set of qualities for the new Line. This strategy also allows for a high volume of

products with low variety, takes into consideration production equipment solely used for specific tasks,

low skilled workers, and production standardization.

B. Develop a sales volume forecast using the least squares method and one other forecasting method.1. Submit a copy of the output from the decision analysis tools you used.2. Compare the results between the two methods you used.

In order to improve the performance of our retail mall stores, a sales forecast can be created

using previous sales trends to develop future sales goals by implementing a process known as

forecasting. Using the least squares(LS) forecasting method I will attempt to project future sales

using a straight line regression series. The LS method uses X and Y intercepts with the changes

in the series is being referred to as the slope. Using the LS method, a sale forecast can be

determined by changes in the line of its slope. The data to be used is found in the Four Corners

Sales chart below.

Four Corners Shuzworld Sales

Quarter Sales

2Q 2007 90,000

3Q 2007 95,000

4Q 2007 98,000

1Q 2008 96,000

2Q 2008 102,000

3Q 2008 99,000

4Q 2008 118,000

1Q 2009 109,000

2Q 2009 124,000

I computed the data using the Excel OM v4 software and the charts below reflects the data output generated by using the least squares method as requested by the task instructions.

Regression

020,00040,00060,00080,000100,000120,000140,000

0 2 4 6 8 10

PeriodDemand (y) Period(x)

Period 1 90,000 1

Period 2 95,000 2

Period 3 98,000 3

Period 4 96,000 4

Period 5 102,000 5

Period 6 99,000 6

Period 7 118,000 7

Period 8 109,000 8

Period 9 124,000 9

Forecast 121861.111 10

On the chart above, the time periods (in quarters) are represented by X. You can see that in the

third quarter of 2009, our projected sales forecast starts at $121,861.11, using the least squares

method as requested by the task instructions. The least squares method is appropriate because I

only needed to project sales for one future quarter and the data provided was a series of numbers

with even intervals.

Another forecasting method that can be used is exponential smoothing, as it is used as a

smoothing constraint to determine future numbers. An accurate forecast is given when trends are

taken into consideration since the exponential smoothing becomes trend adjusted (Heizer &

Render, 2010). Using the Excel OM software to determine the results for the trend adjusted

exponential smoothing forecast generated the following data:

Alpha 0.3

Beta 0.4

Data Forecasts and Error Analysis

Period DemandSmoothed Forecast, Ft

Smoothed Trend, Tt

Forecast Including Trend, FITt

2Q 2007 90,000 90000   90000

3Q 2007 95,000 90000 0 90000

4Q 2007 98,000 91500 600 92100

1Q 2008 96,000 93870 1308 95178

2Q 2008 102,000 95424.6 1406.64 96831.24

3Q 2008 99,000 98381.87 2026.891 100408.8

4Q 2008 118,000 99986.13 1857.84 101844

1Q 2009 109,000 106690.8 3796.564 110487.3

2Q 2009 124,000 110041.1 3618.082 113659.2

Next   116761.5 4858.976 121620.4

The given smoothing constraint of 0.3 and the trend adjustment of 0.4 generates a prediction for

Qtr 3 of 2009 as $121,620.40 in sales. The Excel OM v4 software and forecasting module was

selected with the option for Trend Adjusting Exponential Smoothing because the trend adjusting

exponential smoothing forecast was best calculated using this method to determine an accurate

forecast for the upcoming period. In comparison, the least squares method forecasted a 2009 Qtr

3 sales amount of $121,861.11, while the trend adjusted exponential smoothing method

generated a sales forecast of $121,620.40. A noticeable difference of $240.71 is realized

between the two methods, however, the numbers are very close in relation since forecasting

methods consider trends when calculating figures. Do to the similarities in the calculation

methods, it is difficult to determine which forecast method is most accurate. In order to

determine the accuracy of each method the actual 2009 Qtr 3 results would be needed. However,

since this information is unavailable, it is safe to assume that both forecasts are correct.

Error measurements included in the results provided using the decision analysis tool, can be

calculated by the MAD and the MSE methods. The MAD is the first measure of forecast error

for the least squares method. The MAD is calculated by adding the absolute values of each

individual forecast error and dividing by the number of data periods, while the MSE is a method

of measuring the overall forecast error and is calculated by taking the average squared

differences between the forecasted and the observed values.  The main disadvantage to MSE is

that it accentuates the larger deviations due to the squared term.  The MAPE is calculated as the

average of the absolute difference between the forecasted values and the actual values, then

expressed as a percentage of the actual values.  The exponential smoothing with trend adjustment

forecasts our 10th qtr sales at $121,620.40 and has the following error output of MAD 5785.459,

MSE 57418436 and a MAPE of 5.25%.  Also, the mean average deviation is 4183.51, the

average mean square error is 23356173 and the mean absolute percent error is 3.95%.  We can

use either method because calculations in both forecasts are very close.

C. Discuss how to apply control chart metrics to improve quality in the Shuzworld production line.

Applying the use of control chart metrics to improve the quality in Shuzworld’s production line

can be easily implemented. Control charts are graphical representations of process data over

time and are used to separate natural and assignable causes to variations in production (Heizer &

Render, 2010). Natural causes are the variations typically seen by a company and are caused by

chance. If the variations remain within a normal distribution pattern, then production will remain

in control. Likewise, assignable causes are traceable variations that can be traced to a source,

such as, broken machinery or unskilled workers, which causes decreases in the quality of

production (Heizer & Render, 2010).

In order to implement the use of control charts, we must first develop a control chart, by pulling

a random sampling of our shoes. We must then compare the shoes to each other and inspect

them to determine their quality and detect variations. Doing this will allow us determine the

distribution pattern. This process must be done over several periods of time in order to

determine if an assignable cause exists that needs to be corrected in order to improve production

(Heizer & Render, 2010). It is suggested that the implementation of control chart metrics be

considered, because it will provide us with a visual representation of whether or not our

production is in control. If production is found to be out of control, then it means that there are

high variations in the quality of our product. The indication of a steady pattern of bell curves in

the distribution pattern means that we are in control of our production (Heizer & Render, 2010),

which is exactly what we want to achieve.

The image below is a control chart for our dual-density rubber foam molding machine that

makes soles for most of our shoes. The chart shows a random hourly selection of 15 soles taken

over a 16-hour timeframe. We have set a control limit of 99.73% for this process, with the

standard population deviation at 0.5 inches.

I have also set an upper control limit (UCL) of 10.375 inches and a lower control limit (LCL) of

9.625 inches. You can see that two samples on the chart have fallen outside of these limits, and

are considered to be “out of control”. Additionally, the samples that fall between the UCL and

LCL are considered to have natural variations. However, the out of control samples have caused

the entire process to become erratic and considered out of control. This means that we detected

an assignable cause that must be investigated and discovered, in order to regain control of the

process (Heizer & Render, 2010). It is possible that the assignable cause may be attributed to a

single machine that may require more frequent service, since the erratic samples occurred near

the end of the 16-hour sampling timeframe.

The chart below displays the control limits and sample fraction defectives for 20 operators of the

eyeleting machines. These employees use the machines to create eyelets in both, our boots and

men's shoes. We reviewed 100 items for each worker and counted the errors. The control limit

is 99.73%.

In this chart, there is a UCLp of 0.125 and a LCLp of 0. These attributes are measured on a P-

chart, which means that the measurements are in terms of defects. Looking at the chart above,

we see that two of our employees have fallen outside of the preset limits. Specifically, Operators

13 and 20 are out of control and need to have their work examined closely to determine if a

serious problem exists (Heizer & Render, 2010).

D. References:

Heizer, J. & render, B. (2010). Operations Management (10th Ed). New Jersey: Pearson.

Decision Analysis Task 4 is an attached Power Point