After graduating with a degree in business from Eastern University in Campus Town, USA, Michael Woods realized that he wanted to remain in Campus Town. After a number of unsuccessful attempts at getting a job in his discipline, Michael decided to go into business for himself. In thinking about his business venture, Michael determined that he had four criteria for the new business:

He wanted to do something that he would enjoy.

He wanted a business that would give back to the community.

He wanted a business that would grow and be more successful every year.

Realizing that he was going to have to work very hard, Michael wanted a business that would generate a minimum net income of $28,000 annually.

While reflecting on the criteria he had outlined, Michael, who had been president of his fraternity and served as an officer in several other student organizations, realized that there was no place in Campus Town to have custom sweatshirts made using a silk-screen process. When student organizations wanted sweatshirts for their members or to market on campus, the officers had to make a trip to a city 100 miles away to visit Shirts and More.

Michael had worked as a part-time employee at Shirts and More while he was in high school and had envisioned owning such a shop. He realized that a sweatshirt shop in Campus Town had the potential to meet all four of his criteria. Michael set up an appointment with Jayne Stoll, the owner of Shirts and More, to obtain information useful in getting his shop started. Because Jayne liked Michael and was intrigued by his entrepreneurial spirit, she answered many of Michaels questions.

In addition, Jayne provided information concerning the type of equipment Michael would need for his business and its average useful life. Jayne knows a competitor who is retiring and would like to sell his equipment. Michael can purchase the equipment at the beginning of 2018, and the owner is willing to give him terms of 65% due upon purchase and 35% due the quarter following the purchase.

Michael decided to purchase the following equipment as of January 1, 2018.

Michael has decided to use the sweatshirt supplier recommended by Jayne. Michael learned from talking with Jayne that the supplier is so focused on making quality sweatshirts that many times the shirts are not available for several days. She encouraged Michael to maintain an ending inventory of shirts equal to10% of the next quarters sales. He learned that a gross of good-quality sweatshirts to be silk-screened would cost $1,440. Shirts may only be purchased in agross. Jayne has encouraged Michael to ask the sweatshirt supplier for terms of 60% of a quarters purchases to be paid in the quarter of purchase, with the remaining 40% of the quarters purchases to be paid in the quarter following the purchase.

Michael also learned from talking with Jayne that the ink used in the silkscreen process costs approximately $0.70 per shirt.

Knowing that the silk-screen process is somewhat labor-intensive, Michael plans to hire six college students to help with the process. Each one will work an average of 20 hours per week for 50 weeks during the year. Michael estimates total annual wages for the workers to be $72,000.

In addition, Michael will need one person to take orders, bill customers, and operate the cash register. Allyson Ford, who is currently Director of Student Development at Eastern University, has approached Michael about a job in sales. Allyson knows all of the officers of student organizations on campus. In addition, she is very active in the community. Michael thinks Allyson can bring in a lot of business. In addition she also has the clerical skills needed for the position. Because of her contacts, Michael is willing to pay Allyson $1,200 per month plus a commission of 10% of sales. Michael estimates Allyson will spend 50% of the workday focusing on sales, and the remaining 50% will be spent on clerical and administrative duties.

Michael realizes that he will have difficulty finding a person skilled in computer graphics to generate the designs to be printed on the shirts. Jayne recently hired a graphics designer in that position for Shirts and More at a rate of $500 per month plus $0.10 for each shirt printed. Michael believes he can find a university graphics design student to work for the same rate Jayne is paying her designer.

Michael was fortunate to find a commercial building for rent near the university and the downtown area. The landlord requires a one-year lease. Although the monthly rent of $1,000 is more than Michael had anticipated paying, the building is nice, has adequate parking, and there is room for expansion. Michael anticipates that 75% of the building will be used in the silk-screen process and 25% will be used for sales.

Michaels fraternity brothers have encouraged him to advertise weekly in the Eastern University student newspaper. Upon inquiring, Michael found that a 3 3 ad would cost $25 per week. Michael also plans to run a weekly ad in the local newspaper that will cost him $75 per week.

Michael wants to sell a large number of quality shirts at a reasonable price. He estimates the selling price of each customized shirt to be $16. Jayne has suggested that he should ask customers to pay for 75% of their purchases in the quarter purchased and pay the additional 25% in the quarter following the purchases.

After talking with the insurance agent and the property valuation administrator in his municipality, Michael estimates that the property taxes and insurance on the machinery will cost $2,240 annually; property tax and insurance on display furniture and cash register will total $380 annually.

Jayne reminded Michael that maintenance of the machines is required for the silk-screen process. In addition, Michael realizes that he must consider the cost of utilities. The building Michael wants to rent is roughly the same size as the building occupied by Shirts and More. In addition, Shirts and More sells approximately the same number of shirts Michael plans to sell in his store. Therefore, Michael is confident that the maintenance and utility costs for his shop will be comparable to the maintenance and utility costs for Shirts and More, which are as follows within the relevant range of zero to 8,000 shirts.

Michael estimates the number of shirts to be sold in the first five quarters, beginning January 2018, to be:

First quarter, year 1 9,500

Second quarter, year 1 11,000

Third quarter, year 1 16,500

Fourth quarter, year 1 13,000

First quarter, year 2 15,000

Michael decides to establish his company as a corporation. He will invest $10,000 of his personal savings in the company.

Seeing how determined his son was to become an entrepreneur, Michaels father offered to co-sign a note for an amount up to $18,000 to help Michael open his sweatshirt shop, My Shirt, Inc. However, when Michael and his father approached the loan officer at First Guarantee Bank, the loan officer asked Michael to produce a master budget and estimated financials for 2018.

The loan officer advised Michael that the interest rate on a 12-month loan would be 8%. Michael expects the loan to be taken out as of January 1, 2018. The $18,000 loan & related interest accrued will be paid off in 2018.

The loan officer also requires that Michaels cash budget have at least $3,000 available cash at the end of each quarter to prevent cash flow problems. To ensure this, the officer will give Michael an open line of credit (in addition to the $18,000 loan). The terms of the agreement require borrowing & repayments to be in $1,000 increments at 8% interest. It is assumed that Michael would borrow from the line of credit on the first day of a quarter and make credit repayments on the last day of a quarter as his cash flow allows. Interest on this line of credit is required to be paid on the last day of each quarter that it accrues.

Michael has estimated that his income tax rate will be 15%. He expects to pay the total tax due when his returns are filed in 2019.

Answer the following questions/complete the following items.

Do you think it was important for Michael to stipulate his four criteria for the business (see page 1), including the goal of generating a net income of at least $28,000 annually? Why or why not?

(a) Determine the amount of variable and fixed costs associated with utilities and maintenance using linear regression in EXCEL for each. (Round unit variable costs to four decimal places, and round fixed costs to two decimal places where necessary.)

(b) Give the cost function (TC = VC*Q + FC) for both utilities and maintenances costs. Are these good (reliable) cost functions? Why or why not?

(c) If the company has sales of $12,000 during January of the first year of business, what would total utilities and maintenance cost be?

NOTE: Use the costs functions calculated in 2(a&b) in calculating your budget in #3

In the Excel budget file, on the fourth sheet, use the information found in the case and the master budget to prepare budgeted financials for My Shirt, Inc. for the year ended December 31, 2019. Your budgeted financials must contain FORMULAS ONLY. You may use information from the master budget and the inputs page as needed for your budgeted financials.

(a) Using the information contained in the case and the previous budgets, calculate the estimated contribution margin per unit for 2019. (Hint: Silk-screened labor and the property taxes are both fixed costs, and all question 5 requirements should be calculated using before income tax profit.)

(b) Calculate the total estimated fixed costs for 2018 (including interest and property taxes).

(c) Compute the break-even point in units and dollars for 2018

(a) Michael is very disappointed that the company did not have an income of $28,000 for its first year of budgeted operations as he had wanted. How many shirts would the company have had to sell in order to have had an AFTER-TAX profit of $28,000?

(b)Why does the companys net income differ from its ending cash balance?

Do you think it was a good idea to offer Allyson a salary plus 10% of sales? Why or why not?

Budgeted Income Statement
For the Year Ended December 31, 2018
Sales
COGS
Gross profit
S&A expenses
Income from operations
Interest expense
Income before income taxes
Income tax expense
Net Income
Budgeted Balance Sheet
For the Year Ended December 31, 2018
ASSETS
Current Assets
Cash
Accounts Receivable
Merch. Inventory
Total Current Assets
PP&E
Equipment
A/D - Equipment
Total PPE
Total Assets
LIABILITIES & STOCKHOLDER'S EQUITY
Current Liabilities
Accounts Payable
Interest Payable
Taxes Payable
Total Current Liabilities
Other Liabilities
Notes Payable
Total Other Liabilities
Total Liabilities
Stockholder's Equity
Common Stock
Retained Earnings
Total Stockholder's Equity
Total Liabilities & Stockholder's Equity