Case study 1: True Yellow Greenhouse

(TOOLS FOR EVALUATING OPERATING DECISIONS)

Abu works as an engineer and his wife, Aminah, teaches secondary school. About five years ago they build a 30 x 12 greenhouse to grow tomatoes to sell at a farmers market and to local grocery stores. The project started as a hobby, but business has grown and now Abu and Aminah want to evaluate several changes in the business to improve their return on equity, because Abu is considering retiring and working full-time in the greenhouse. They have decided to use volume-cost analysis to evaluate the changes.

Abu, with the help of his accountant, has determined that True Yellows fixed costs or overhead for the coming year will be RM5,000. They produce about 17,600 kg of tomatoes per year and their average selling price is about RM1.50/kg. Their cost of goods sold equals about RM0.75/kg and their additional costs that seem to vary with sales amount to about RM0.25/kg.

Questions

1. Calculate the breakeven point for True Yellow Greenhouse in RM.

2. The owners, Abu and Aminah, have about RM100,000 invested in the business. Their desired rate of return on this investment is 10 percent. What volume of business (in RM) must be generated to reach this ROE goal?

3. Abu expects to eliminate his part-time labor, because he will work in the greenhouse full time, which amounts to a reduction in variable costs of RM0.17/kg. With no other changes to the base situation, what impact would have this have on the business? Show your answer in RM, and draw a graph to show the changes.

4. Abu and Aminah are considering an upgrade to some of their watering equipment and they expect the capital investment to cost about RM10,000, including installation. Abu assumes this new equipment can be depreciated over a five year period. If the depreciation for the equipment is equal each year and there is no salvage value, what additional sales will True Yellow Greenhouse need for this to be a profitable decision? Assume no other changes will be made to the base situation. Answer this question in RM.

5. Abu and Aminah are interested in ways for True Yellow to increase sales. One change they are considering is to reduce the selling price for their tomatoes. They hope this change will increase sales in the near term and help them maintain sales later if a competitor should enter the market. What would the impact of a 10 percent price reduction have on the business? Assume no other changes are made to the base situation in Question 1. Answer this question in RM.