ADVANCED DIPLOMA IN FINANCIAL MANAGEMENT:

Toocool (Pty) Ltd is a Cape Town-based T-shirt manufacturer. The company was established five years ago by a group of ambitious young graduates, who saw a gap in the market for high quality T-shirts. James Mokoena, Managing Director of the company, explains: We had a look at the market, and saw Nike, Billabong, Adidas, Diesel and so on. All overseas brand names, and not a single South African brand in sight. So we decided to create one. Toocool TM was born, and the baby is now a healthy five-year-old. Im proud to say that we compete with the best in the world in terms of quality, styling and comfort. Volume growth and profitability have been pretty good as well. Now, I reckon its time to look at Phase Two of our growth plan. The Toocool management team believes that it has identified another market opportunity, this time in the lower end of the T-shirt market. There is always going to be a demand for cheaper T-shirts, and we want a part of that market as well. There will be tough competition from the importers, but well leverage off the Toocool brand name by calling our cheaper range Toocool 2. Were just not sure how to evaluate the financial viability of the range, and thats where you guys come in. You guys are a management consulting firm, specializing in managerial accounting issues. You obtain the following information from James Mokoena regarding expected sales revenues and costs for the Toocool 2 range for the next financial year: (1) The company expects to manufacture and sell 50 000 Toocool2 T-shirts during the next financial year, at a selling price of R 54 each. (2) Material for next years Toocool2 production is in stock. It was purchased recently for the ToocoolTM range, but failed the companys strict quality tests. The cost of this material was R1.1 million, and it will be of suitable quality for the new, cheaper T-shirt range. (3) If not used for the new range, the material will be sold locally for R1.1 million, or will be returned to the supplier for a full credit. In both cases, Toocool (Pty) Ltd will have to pay transport costs of R100 000. (4) Direct labour costs on the new line will amount to R28.00 per hour. Each T-shirt will require half-an-hour of direct labour time. A once-off payment of R30 000 will be payable to a labour broker in the first year, for recruiting suitably qualified workers. (5) Variable manufacturing overheads will be made up of two charges: (i) Electricity and Maintenance (ii) Sundries Electricity and Maintenance will cost R24.00 per machine hour, while Sundries will cost R2.00 per direct labour hour. Each T-shirt will require 10 minutes of machine time. (6) The company has unused factory space which can be used for the Toocool2 production line. The line will take up 20% of the floor area, so well have to allocate 20% of Fixed Manufacturing Overhead costs to Toocool2 production, James says. Total Fixed Manufacturing Overheads for the next year are expected to be R1.2 million. (Before the Toocool2 project was thought of, Fixed Manufacturing Overheads for the firm were expected to be R1.0 million for the year.) (7) Additional Sales and Administration charges arising from the new line will be R240 000 per year. (8) Cutting, trimming, pressing and packaging of the new T-shirt line will be done by direct labour, but all T-shirts will be machine-stitched. A stitching machine, which cost R500 000 two years ago, is in storage. (Accumulated depreciation on this machine is R200 000, based on 20% per annum straightline depreciation.) The machine will be serviced and installed on the Toocool2 production line. Once-off servicing, moving and installation costs will be R20 000. The machine varies the stitching tension a bit, so some of the stitching will be a bit loose, but thats okay on a lower-quality line, James explains. (9) Toocool (Pty) Ltd is currently renting out some of their spare warehouse space at R48 000 per year. This space will be needed for Toocool2 products. The rental agreement can be cancelled before the beginning of the new financial year. Required: 1.1 Toocool (Pty) Ltd must decide whether to launch the new Toocool2 product range or not. Using relevant cost principles, prepare a financial analysis of the Toocool2 range for the next financial year. (18) 1.2 On the basis of this one-year financial analysis, briefly explain why the company should, or should not, launch the new product range? (2) 1.3 Would your financial results be different for Year 2? Show all your workings. (You may assume the same sales and production volumes, and you may ignore selling price and cost inflation). (5) 1.4 Apart from the financial issues mentioned above, identify and outline any other issues (strategic or non-strategic) that the company should take into account before launching the Toocool2 product range. Your solution can also suggest any changes to the plan that you feel would be appropriate. (10)