Business Description:

Your project group will assume the role of young entrepreneurs to start a small company. Your company will rent a retail cart inside the Stoneridge Mall to buy plain T-shirts and imprint them with one of the twelve beautiful pictures exclusively designed for your company by a famous artist who is a friend of yours. He has agreed to design twelve super attractive T-shirt pictures for you each year at a special discount. Your target customers are teenagers and young adults who have your kind of good taste. Your business is scheduled to launch on August 1,2017. Cost information:

1) Stoneridge charges you $4,000 rent per month, which includes utilities, telephone, cleaning, and maintenance. You estimated that 90% of the rent was related to factory operations and 10% was related to selling and administrative activities.

2) You will order white, cotton t-shirts from a T-shirt wholesaler. Each T-shirt costs (including taxes, shipping, and handling) $3.25 to purchase.

3) To store T-shirts that were bought, but not yet imprinted, you will rent a storage unit. The storage unit costs you $150 per month.

4) You agreed to pay your artist friend a $12,000 annual contract fee plus a $350 design fee for each of the 12 T-shirt pictures designed. This same term is renewable for the next 3 years. Each T-shirt picture will only be used for one year. Therefore, in the second year, 12 new pictures will be designed at $350 each and another $12,000 annual contract fee will be charged.

5) You will buy several items before that start of your business:

[a] A computer and a printer: You will pay $8,000 (including taxes, shipping and handling) to buy a computer and a printer. You expect both to last about 3 years without salvage value. You will use the straight-line method for depreciation. You estimate that about 90% of the computer and printer will be used for factory operations and 10% will be for selling and administrative activities.

[b] A heat press machine: You will pay $3,500 (including taxes, shipping and handling) for a heat press machine. The machine is used for imprinting t-shirts only and is expected to last 3 years without salvage value.

[c] Transfer paper: Each case of transfer paper costs $600 and contains 1,200 sheets of 8.511 transfer paper. You expect to use one transfer paper to print one T-shirt.

[d] Ink-jet cartridges: On average, each cartridge costs $75 and can make 750 prints. Each Tshirt requires one print. You also need to print flyers, etc. for selling and administrative purposes. For this non-manufacturing printing, you will print about one page for every 5 T-shirts sold.

[e] Laser paper: You will buy several reams of laser paper to print promotion flyers, etc. Each ream costs $20 and contains 200 sheets of 8.511 laser paper.

6) Wrapping paper and box: Each T-shirt costs about $0.25 to wrap and box. Wrapping and boxing are not considered as manufacturing.

7) You will hire three fellow students as part-time workers. They not only help you operate the machine, but also help fold, wrap and box T-shirts. Sometimes, three of them work at the same time. But, sometimes they dont because of their different class schedules. On average, printing 10 shirts will take one labor hour. Folding and packaging 20 shirts also will take about one labor hour. You will pay each of your workers $9 per hour. Folding and wrapping are not considered as manufacturing.

8) You (the owners) do all the selling and administrative work by yourselves. You will pay yourselves a total of $15,000 per year (to be divided among all owners).

9) To protect your business from legal obligation, you will purchase a liability insurance that will cost you $3,000 per year.

10) You will hold four end-of-quarter parties to promote sales of your t-shirts. Each party costs you about $1,500.

Project Requirements:

1) What and how much of your costs are variable costs? List your manufacturingand non-manufacturing variable cost items and present each of them in cost per T-shirt basis.

2) What and how much of your costs are fixed costs? List your manufacturing andnon- manufacturing fixed cost items and present each of them in total cost per year.

3) Write out your yearly cost formula in Y = a + bX format. Be sure to include both manufacturing costs and non-manufacturing costs in the cost formula.

4) Assume that you make and sell 8,800 t-shirts in the first year. Use your cost formula to calculate your first years total cost. If you sell these t-shirts at $18 each, how much would net profit be in the first year?

6) Now you have developed your cost estimates, lets do some evaluations on this proposed business. a. Continue to assume that 8,800 t-shirts will be made and sold in the first year. What is your product cost per unit under absorption costing? What is your product cost per unit under variable costing?

b. Based on the estimated sales level of 8,800 t-shirts for the first year, prepare your companys (forecasted) income statement for the year ended on 07/31/2018 using both (1) the traditional format based on the absorption costing and (2) the contribution format based on the variable costing.

c. Calculate contribution margin per T-shirt and contribution margin ratio.

d. Calculate how many T-shirts you need to sell in order to break-even. Calculate how much sales in dollars you need to make in order to break-even. (Use break-even formulas.)

e. Calculate how many T-shirts you need to sell in order to make $14,000 target profit for the year.

f. Continue to assume that 8,800 T-shirts will be made and sold during the first year. Calculate your (1) margin of safety and (2) degree of operating leverage (DOL) for your business. What do these figures tell you about how risky your business is?

g. If sales could increase by 1,760 shirts (i.e. a 20% increase), by how much in dollars would net operating income increase? By what percentage would net operating income increase? (Use the quick way, i.e. contribution margin concept and DOL, you have learned in class to answer these questions. Do not recalculate net operating income.)

h. Prepare a contribution format income statement assuming a sales increase by 20% to 10,560 shirts. Compare your new net operating income with your answer in Question b and prove mathematically that your answers to the two questions in Question g are correct.

i. Ignore Questions g and h. If the cost per plain t-shirt is expected to increase by 15% and sales (in number of T-shirts) are expected to be 5% less, how much is your projected net operating income (or loss)?

j. Continue Question i. If the only expense you can cut is the salary paid to yourselves, how much salary should you cut in order to break even?

k. Ignore Question i and j. Assume that you have produced 8,800 t-shirts, but the actual sales for the first year turn out to be 8,200 T-shirts instead of 8,800. I.e. you will have 600 T-shirts left at the end of the first year. Prepare (1) a traditional format income statement and (2) a contribution format income statement. Are the two net operating income figures the same? Why or why not?

l. Continue k. At what amount would inventory be reported in the balance sheet of 07/31/2018 under (1) the absorption costing and (2) variable costing? Are the two ending inventory figures the same or different?Why?

7) Calculate the total amount of cash you will need to have before the launching day of your business, in order to buy all necessary equipment and machines, to purchase all materials and supplies needed for the first three months operations, and to pay your employees first three months salaries. Assume that your parents have agreed to loan you this amount, interest free. The following is information regarding the cash payment needs for your variable costs and fixed costs:

a. Variable Costs and Expenses: For every variable cost item, you decide to buy sufficient quantity for making the first 2,300 T-shirts. You also want to prepare sufficient amount of cash to pay for the labor costs needed for making, folding, and wrapping the first 2,300 T-shirts. Assume that you can pay your workers for a fraction of an hour. However, you cannot purchase a fraction of an ink-jet cartridge or a partial case or ream of paper.

b. Fixed Costs and Expenses: In addition to covering variable costs for the first 2,300 T-shirts, your initial amount of cash should be sufficient to pay for the first quarters cash needs for your fixed costs. For your fixed cost items, payments will be made according to the following pattern: (Note: The following cost item labels are according to the cost list of requirement #3.) Cost items 1), 3), and 9) will be paid on a monthly basis.

Cost items 4), 5a), and 5b) will be completely paid for on January 1st.

The first quarterly party, cost item 10), will be paid at the end of the first quarter.

Cost item 8) will not be paid until the end of the first year of operations.

8) Prepare a cash budget for your companys first year of operations. (NOT the first three months or the first 2,300 T-shirts!) Continue to assume that the selling price is $18 and that 8,800 t-shirts will be made and sold in the first year. Assume all sales are cash sales and that all costs and expenses are paid in cash. Prepare cash budget for the entire year; do not separate the budget into four quarters. Your initial cash balance is the amount you reported in Item 2 above. You decide to keep a cash balance of $20,000 at July 31, 2018 and use the extra cash, if there is, to pay back part of the loan you borrowed from your parents.

9) Calculate the first years estimated Simple Rate of Return (i.e. accounting rate of return) of your business. Use the net income under the absorption costing. For simplicity, use the amount of money you originally borrowed from your parents as the amount of initial investment for this calculation.

10) After reviewing the budgeted income statement and the simple rate of return for your companys first year of operations, you and your partners are disappointed at the low estimated net income (net loss) and rate of return. So, you begin to discuss business strategies that you hope will help to improve profitability.

a. Develop a business strategy which will involve at least three changes in some (or all) of the following attributes: (1) variable cost per t-shirt, (2) total fixed cost, and (3) selling price per T-shirt. Your three (or more) changes can come in any combination of (1), (2), and (3). For instance, you could propose that you use better quality plain t-shirts as raw material (which will change (1)), increase advertising budget (which will change (2)), and then sell the t-shirts at a higher price (which will change (3)), and hope that you will be able to sell more T-shirts after adopting this strategy. Alternatively, your business strategy could be to draw the T-shirt pictures yourself instead of using the artist (which will change (2)), move your business location to a less expensive location (which will also change (2)), and lower the price (which will change (3)). Please use your imagination to come up with a more creative strategy than proposed here! (Innovative strategies will receive extra points.) Describe your strategy clearly and justify why you believe your strategy will work.

b. Indicate by how much your variable cost per T-shirt, total fixed cost, and selling price will change under your strategy. Revise your overall cost formula (requirement #4.) according to your strategy.

c. What would the new contribution margin per T-shirt be? What would the new break-even level of annual sales (in number of T-shirts) be under your strategy?

d. Under your strategy, how many T-shirts do you think you will be able to produce/sell in a year in the best (but realistic) scenario? How many T-shirts do you think you can produce/sell in the worst scenario? Assume that the T-shirts produced will be all sold. Calculate your net income under each of the two scenarios. (Note: Calculating net operating income would be easier using the variable costing approach. Do not hesitate to give realistic estimations. Your report grades will have nothing to do with the profitability of your business.)