Analytics Exercise 20-1 (Algo)

Steve majored in accounting and likes to pump the numbers. He has done a great job of keeping the books and selling the company to some small venture capital people in the area. Last year, he was successful in getting them to invest $2,000,000 in the company (a onetime investment). There were some significant strings attached to this investment in that it stipulated that only $100,000 per year could go toward paying the salary of the two principals. The rest had to be spent on the website, advertising, and inventory. In addition, the venture capital company gets 26 percent of the company profits, before taxes, during the first four years of operation, assuming the company makes a profit.

Your first job is to focus on the firms inventory. The company is centered on selling the premium sweaters to college football fans through a website. Your analysis is important since a significant portion of the companys assets is the inventory that it carries.

The business is cyclic, and sales are concentrated during the period leading up to the college football season, which runs between late August and the end of each year. For the upcoming season, the firm wants to sell sweaters to only a few of the largest schools in the Midwest region of the United States. In particular, they are targeting The Ohio State University (OSU), the University of Michigan (UM), Michigan State University (MSU), Purdu University (PU), and Indiana University (IU). These five schools have major football programs and a loyal fan base.

The firm has considered the idea of making the sweaters in their own factory, but for now they purchase them from a supplier in China. The prices are great, but service is a problem since the supplier has a 20-week lead time for each order and the minimum order size is 5,000 sweaters. The order can consist of a mix of the different logos, such as 2,000 for OSU, 1,500 for UM, 750 for MSU, 500 for PU, and 250 for IU. Within each logo sub lot, sizes are allocated based on percentages and the supplier suggests 20 percent X-large, 50 percent large, 20 percent medium, and 10 percent small based on their historical data.

Once an order is received, a local subcontractor applies the monograms and ships the sweaters to the customer. They store the inventory of sweaters for the company in a small warehouse area located at the subcontractor.

This is the companys second year of operation. Last year they only sold sweaters for three of the schools, OSU, UM, and PU. They ordered the minimum 5,000 sweaters and sold all of them, but the experience was painful since they had too many UM sweaters and not enough for OSU fans. Last year they ordered 2,230 OSU, 1,820 UM, and 950 PU sweaters. Of the 5,000 sweaters, 347 had to be sold at a steep discount on eBay after the season. They were hoping not to do this again.

For the next year, you have collected some data relevant to the decision. Exhibit 20.12 shows cost information for the product when purchased from the supplier in China. Here we see that the cost for each sweater, delivered to the warehouse of our monogramming subcontractor, is $55.83. This price is valid for any quantity that we order above 5,000 sweaters. This order can be a mix of sweaters for each of the five schools we are targeting. The supplier needs 20 weeks to process the order, so the order needs to be placed around April 1 for the upcoming football season.

COST INFORMATION FOR THE BIG TEN SWEATERS
China supplier cost
Material	$	26.00
Labor		11.50
Overhead		1.25
Transportation within China		1.00
Supplier profit		8.90
Agent's fee		2.68
Freight (ocean carrier)		1.50
Duty, insurance, etc.		3.00
Total supplier cost				$	55.83
Domestic subcontractor cost
Monogram material	$	3.50
Labor		7.00
Total subcontractor cost				$	10.50
Total (per sweater)				$	66.33

FORECAST DATA FOR THE BIG TEN SWEATERS
	AVERAGE FOOTBALL GAME ATTENDANCE	LAST YEARS ACTUAL SALES (FULL PRICE)	RHONDAS FORECAST FOR NEXT YEAR	STEVES FORECAST FOR NEXT YEAR	MARKET RESEARCH FORECAST FOR NEXT YEAR	AVERAGE FORECAST	STANDARD DEVIATION
Ohio State	105,261	2,230	2,470	2,230	2,730	2,477	250
Michigan	108,933	1,523	1,760	1,560	1,940	1,753	190
Purdu	50,457	900	1,060	920	1,110	1,030	98
Michigan State	74,741	-	1,700	1,560	1,590	1,617	74
Indiana	41,833	-	560	560	420	513	81
Penn State	107,008
Wisconsin	80,109
Iowa	70,214
Illinois	59,545
Minnesota	50,805
Northwestern	24,190
Nebraska	85,071
Total		4,653*	7,550	6,830	7,790	7,390	347**

*347 sweaters were sold through eBay for $49 each (the customer pays shipping on all orders).

**Calculated assuming the demand at each school is independent = i=1N2ii=1Ni2

Our monogramming subcontractor gets $10.50 for each sweater. Shipping cost is paid by the customer when the order is placed.

In addition to the cost data, you also have some demand information, as shown in Exhibit 20.13. The exact sales numbers for last year are given. The exhibit indicates the retail or full price sales for the sweaters that were sold for $125 each. Sweaters that we had at the end of the season were sold through eBay for $49 each and were not monogrammed. Keep in mind that the retail sales numbers do not accurately reflect actual demand since they stocked out of the OSU sweaters toward the end of the season.

You are curious as to how much Rhonda and Steve made in their business last year. You do not have all the data, but you know that most of their expenses relate to buying the sweaters and having them monogrammed. You know they paid themselves $50,000 each and you know the rent, utilities, insurance, and a benefit package for the business was about $22,000.

a. What was the net pre-tax profit for their business last year, after deducting salary and overhead? (Do not round intermediate calculations. Round your answer to the nearest dollar amount.)

b. If they must pay 50% in taxes after deducting their venture capital firm payment, what was the increase in cash that their business accrued last year? (Do not round intermediate calculations. Round your answer to the nearest dollar amount.)