Each founder has now settled into their roles and begin work. It didn't take Andrea long to come up with a design. She did a lot of research on backpack designs and had extensive discussions with Tony on where he believed the designs needed improvement. What they needed was a prototype so they could cost it out and determine feasibility. Tony loved the design, but had a few suggestions that Andrea incorporated. Then she got to work on the prototype. Using the equipment, she had available and measuring production time herself she came up with the following specifications: Tony Matheson plans to graduate from college in May 2021 after spending four years earning a degree in sports and recreation management. Since beginning T-ball at age five, he's been actively involved in sports and enjoys the outdoors. Each summer growing up, he and his father would spend two weeks at a father/son outdoor camp. These fond memories are part of the reason he chose his major. Tony is an avid outdoor adventurer, but he's disappointed in the gear that's available to him. Tony has looked all over, but he can't find the right pack to fit his needs. Tony's friend Andrea Michales also recently graduated from college with a degree in fashion design. Unfortunately, she has not been able to find a job in her field yet. In speaking with Tony about his equipment search, Andrea has an idea. She would like to work with Tony to design the perfect backpack. Tony is excited about this possibly and thinks he can monetize this and market it to outdoor enthusiasts like himself. Unfortunately, neither Tony nor Andrea has the business background needed to organize this. This where Suzie Ramos can help. Suzie also plans to graduate in May 2021 with a major in business. Suzie and Tony first met their sophomore year and have been friends ever since as they share a strong interest in sports and outdoor activities. They decide to name their company Great Adventures. They will begin by manufacturing backpacks; but anticipate bringing other lines into their business. Product Standards Standard Quantity Standard Standard or Hours Price or Rate Cost Direct Materials Fabric Metal Gromets Plastic Buckles Velcro 2.5 yards 12 14 1 yard $ $ $ $ 2.50 $ 6.25 0.50 $ 6.00 1.50 $ 21.00 0.75 $ 0.75 Total Standard Cost Per Unit Of Material $ 34,00 Direct labor 4.5 hours $ 19.00 $ 81.00 Variable Manufacturing Overhead 4.5 hours $ 2.50 11.25 Total Unit Product Costs $126.25 Tony introduced Suzie to Andrea, and they hit it off immediately. Suzie indicated that the first thing we need to do is create a budget, so we know what we're getting into, and also to obtain any financing needed. She asked Tony to research what their price point should be. Suzie also asked Andrea if she could build into her design the amount of material and labor needed to produce one backpack. Suzie will also need to know if any specialized equipment will need to be procured. Suzie indicated that she would begin exploring ways to allocate indirect costs into the product. She will also handle the general accounting areas of the budget. The variable Manufacturing Overhead came from Suzies calculations, but she warned they're just preliminary. We'll have to do a more thorough allocation later. Tony was excited about the proto-type budget. He said at first glance he thought we could work with that and create a competitive price point. He shared the preliminary designs with some friends at local outdoor equipment stores and they loved it. Tony thinks they're on to something. Equipment List: Tony spent the next week crunching the numbers, looking at market demographics and where he believed their catchment area would be and determine that he could sell the pack at 1.50 percent above product costs. He put together a three-month sales forecast for 2021 as follows: 3 Heavy Duty Sewing Machine 2 Cutting Machines 1 1 Gromet Fastening Machine 1 Crimping Machine $2,500 per machine $1,500 per machine $ 1,200 per machine $800 per machine The machines have a four-year life and no salvage value Budgeted Sales in Units October November December 1000 1500 1500 General and Administrative Budget: Ending 12-31-2021 Tony also indicated he expects that sales will grow at a modest 5% through 2022 Officers Salaries Office Salaries Payroll Tax Indirect Labor Rent Utilities Depreciation Selling & Aministrative Selling & Administrive Fixed Interest Expense Insurance Office Supplies $ 18,750.00 $ 3,000.00 8,700.00 $ 37,500.00 $ 6,250.00 $ 1,375.00 7 $3 per unit $ 7,000.00 ? $ 9,000.00 $ 1,250.00 Andrea looked at the sales figures and started getting a bit nervous. There was a lot of work to do! Its worse than that said Tony. In order for us to maintain a steady flow of sales we need some inventory on hand to meet our lead times, Tony advised Andrea that we would need 10 percent of the following months sales in ending inventory to ensure they did not have a stock out. Tony knew that delays in order would have a detrimental effect on the new company's reputation as being unreliable. I see said Suzie; in that case we better build an ending inventory into our raw material budgets as well. We would need a 20% ending inventory based on the next months cost of goods sold. While Andrea and Tony were busy on the design production and marketing side of the new business, Suzie was busy with the finance side. In speaking with Andrea, Suzie was informed that to meet production requirements, the company would need the following equipment: All general and Administrative Expenses would be paid in the month Andrea was able to find materials supplies she felt would offer quality products and be reliable. She was even able to negotiate credit terms. The suppliers were willing to allow payment in 30 days following the month of purchase. Tony discussed the sales with the group. In discussions with potential customers, he realized they were cash Strapped themselves. They would gladly take the goods on consignment, but if Great Adventures required a sale, they would need at least 30 days pas the month of sale to pay. Tony didn't want to get into a consignment arrangement, so he agreed to the terms. Things were coming together. . General and Administrative Budget: Ending 12-31-2021 The actual products cost data for three months ending 12-31-2021 was as follows: Actual Sales in Units October November December 800 1200 2500 Officers Salaries Office Salaries Payroll Tax Indirect Labor Rent Utilities Depreciation Selling & Aministrative Selling & Administrive Fixed Interest Expense Insurance Office Supplies $ 15,250.00 $ 1,850.00 $ 6,840.00 $ 32,500.00 $ 6,250.00 $ 1,875.00 2 $3 per unit $ 8,500.00 ? ? $ 9,250.00 $ 1,850.00 Product Standards Standard Quantity Standard Price or Rate Standard Cost or Hours Direct Materials Fabric Metal Gromets Plastic Buckles Velcro 2.75 yards 12 13 1.5 yard $ $ $ $ $ 3.50 $ 0.50 $ 0.75 $ O.BS $ 6.25 6.00 21.00 0.75 Total Standard Cost Per Unit of Material $ 34.00 Direct Labor 5.5 hours $ 17.50 $ 81.00 Variable Manufacturing Overhead 4.5 hours $ 3.50 11.25 Three months of actual operations went by fast! The group now had time to evaluate operations and make some decisions. Things were pretty rocky for the first three months of their business, and they decided to fund any production needs from their savings during their growth phase of the business. However, they knew this could not continue and were intending on presenting their business plan to First National with the line of credit to be available at the first of the year. Covering their first full year of business. Suzie met with Mrs. Cheryl Biggs Business Lending Manager at First National Bank and had a very nice conversation: Mrs. Biggs: How are you financed currently? Suzie: Well, each of the founders put in $10,000 of their own funds. We also borrowed an additional $10,000 in unsecured loans from our parents. Any additional shortfalls come out of our collective savings. The loans are at 6% and are due in five years. Mrs Biggs: What do you think your financing needs will be from us? Suzie: We're looking for $100,000 dollars as a working capital loan. We would intend to access principle as needed. Total Unit Product Costs $ 126.25 Actual General & Administrative Costs were as follows: Mrs. Biggs: Well, we've done this type of loan for similar businesses, so we believe we can help. However, we're going to need some information. Based on your first three months of business When Suzie got back to her home office, she dug right in making phone calls and researching the business environment. She put together what she believed would be a reasonable general and administrative budget. Andrea indicated she would like to invest in a new cutting/sewing automated system. The piece of equipment would reduce manufacturing direct labor by 50%. It would also reduce material costs by 15% saving on waste. Tony loved the idea saying that he could increase sales by 10% because the total price point would be lowered by the savings. The machine would cost $150000. It would require the use of working capital of $25000 to start but this would be returned at the end of the useful life. The machines useful life would be 6 years. In order to make this investment, the bank would require: 1.) Budgets as follows: (See Chapter 8) a. Sales Budget b. Production Budget c. Direct Materials Budget d. Direct Labor Budget e. General and Administrative Expense Budget f. Cash Budget 2.) Variable Cost Income Statement 3.) Flexible Budget 4.) Breakeven level in units and dollars see chapter 2/3 5.) Margin of Safety See chapter 2/3 6.) Degree of Operating Leverage See Chapter 2/3 7.) For any new equipment purchases we would issue a separate loan but would need a net present value analysis and a payback analysis. (See Chapter 7) 8.) Terms of the line of credit would be at 12% with interest paid monthly on outstanding balances. Draws would need to be made in increments of $1,000. 1.) A positive NPV using the loan rate of 12% 2.) A payback not to exceed the useful life of the machine (See Chapter 7) Once the loan is approved, we of course will have some covenants needed to be adhered to related to variances between your actual activity and budgeted activity. Suzie considered this information and indicated she will get back to Mrs. Biggs with the Information Requested. She knew she had a lot of work to do. Tony is still struggling with the price point. He understands that Manufacturing Overhead will be assigned to the product on the basis of direct labor hours. He wants to consider a more meaningful allocation method. Doing a little research on his own, he discovered that an activity-based allocation method might be a better allocation method, particularly given that the new machine will reduce labor cost and may no longer be an accurate driver. Currently Great Adventures uses a plantwide overhead. Manufacturing Overhead Consists of Variable Costs Estimated to be $150,000 per year variable manufacturing costs allocated on the basis of direct labor hours. And $48,500 of fixed manufacturing overhead See Chapter 4 The actual sales for the first quarter of 2022 were as follows: Actual Sales in Units First Quarter 2022 Tony would like to switch to the following activity base drivers January February March 2600 2200 2300 Customer Orders Product Design Order Costs Set Up Requirements: Tony estimated the pools would consist of the following: Based on the information provided in the case: ACTIVITY BASE Customer Orders Product Design Machine Set Ups Order Size $ $ $ $ 375,000 Number of orders 22,500 Number of Designs 675,000 Number of Set-Ups 427,500 Machine Hours 1,500 50 2,500 75,000 $ 1,500,000 1.) Sales budget quarter ending in 2021 2.) Production budget Quarter Ending in 2021 3.) Direct materials Budget Quarter Ending in 2021 4.) Direct Labor Budget Quarter Ending in 2021 5.) Manufacturing Overhead Budget Quarter Ending in 2021 6.) Actual-Flexible-Planning Income Statement w/ Variance 7.) Direct Material Price and Quantity Variances 8.) Direct labor rate and efficiency variances 9.) Variable Overhead Rate & Efficiency Variances 10.) Net Present Value Analysis 11.) Make or Buy Analysis See Chapter 5 Suzie had another suggestion. There is a Filipino company that had contacted he regarding opportunity to offshore the manufacturing operations. The company offered to produce the backpack design and sell the unit back to the Great Adventures at: $125 a unit See chapter 6 Provide a comment on the viability of Great Adventures based on the information above. Make any recommendations for price or cost adjustments. Each founder has now settled into their roles and begin work. It didn't take Andrea long to come up with a design. She did a lot of research on backpack designs and had extensive discussions with Tony on where he believed the designs needed improvement. What they needed was a prototype so they could cost it out and determine feasibility. Tony loved the design, but had a few suggestions that Andrea incorporated. Then she got to work on the prototype. Using the equipment, she had available and measuring production time herself she came up with the following specifications: Tony Matheson plans to graduate from college in May 2021 after spending four years earning a degree in sports and recreation management. Since beginning T-ball at age five, he's been actively involved in sports and enjoys the outdoors. Each summer growing up, he and his father would spend two weeks at a father/son outdoor camp. These fond memories are part of the reason he chose his major. Tony is an avid outdoor adventurer, but he's disappointed in the gear that's available to him. Tony has looked all over, but he can't find the right pack to fit his needs. Tony's friend Andrea Michales also recently graduated from college with a degree in fashion design. Unfortunately, she has not been able to find a job in her field yet. In speaking with Tony about his equipment search, Andrea has an idea. She would like to work with Tony to design the perfect backpack. Tony is excited about this possibly and thinks he can monetize this and market it to outdoor enthusiasts like himself. Unfortunately, neither Tony nor Andrea has the business background needed to organize this. This where Suzie Ramos can help. Suzie also plans to graduate in May 2021 with a major in business. Suzie and Tony first met their sophomore year and have been friends ever since as they share a strong interest in sports and outdoor activities. They decide to name their company Great Adventures. They will begin by manufacturing backpacks; but anticipate bringing other lines into their business. Product Standards Standard Quantity Standard Standard or Hours Price or Rate Cost Direct Materials Fabric Metal Gromets Plastic Buckles Velcro 2.5 yards 12 14 1 yard $ $ $ $ 2.50 $ 6.25 0.50 $ 6.00 1.50 $ 21.00 0.75 $ 0.75 Total Standard Cost Per Unit Of Material $ 34,00 Direct labor 4.5 hours $ 19.00 $ 81.00 Variable Manufacturing Overhead 4.5 hours $ 2.50 11.25 Total Unit Product Costs $126.25 Tony introduced Suzie to Andrea, and they hit it off immediately. Suzie indicated that the first thing we need to do is create a budget, so we know what we're getting into, and also to obtain any financing needed. She asked Tony to research what their price point should be. Suzie also asked Andrea if she could build into her design the amount of material and labor needed to produce one backpack. Suzie will also need to know if any specialized equipment will need to be procured. Suzie indicated that she would begin exploring ways to allocate indirect costs into the product. She will also handle the general accounting areas of the budget. The variable Manufacturing Overhead came from Suzies calculations, but she warned they're just preliminary. We'll have to do a more thorough allocation later. Tony was excited about the proto-type budget. He said at first glance he thought we could work with that and create a competitive price point. He shared the preliminary designs with some friends at local outdoor equipment stores and they loved it. Tony thinks they're on to something. Equipment List: Tony spent the next week crunching the numbers, looking at market demographics and where he believed their catchment area would be and determine that he could sell the pack at 1.50 percent above product costs. He put together a three-month sales forecast for 2021 as follows: 3 Heavy Duty Sewing Machine 2 Cutting Machines 1 1 Gromet Fastening Machine 1 Crimping Machine $2,500 per machine $1,500 per machine $ 1,200 per machine $800 per machine The machines have a four-year life and no salvage value Budgeted Sales in Units October November December 1000 1500 1500 General and Administrative Budget: Ending 12-31-2021 Tony also indicated he expects that sales will grow at a modest 5% through 2022 Officers Salaries Office Salaries Payroll Tax Indirect Labor Rent Utilities Depreciation Selling & Aministrative Selling & Administrive Fixed Interest Expense Insurance Office Supplies $ 18,750.00 $ 3,000.00 8,700.00 $ 37,500.00 $ 6,250.00 $ 1,375.00 7 $3 per unit $ 7,000.00 ? $ 9,000.00 $ 1,250.00 Andrea looked at the sales figures and started getting a bit nervous. There was a lot of work to do! Its worse than that said Tony. In order for us to maintain a steady flow of sales we need some inventory on hand to meet our lead times, Tony advised Andrea that we would need 10 percent of the following months sales in ending inventory to ensure they did not have a stock out. Tony knew that delays in order would have a detrimental effect on the new company's reputation as being unreliable. I see said Suzie; in that case we better build an ending inventory into our raw material budgets as well. We would need a 20% ending inventory based on the next months cost of goods sold. While Andrea and Tony were busy on the design production and marketing side of the new business, Suzie was busy with the finance side. In speaking with Andrea, Suzie was informed that to meet production requirements, the company would need the following equipment: All general and Administrative Expenses would be paid in the month Andrea was able to find materials supplies she felt would offer quality products and be reliable. She was even able to negotiate credit terms. The suppliers were willing to allow payment in 30 days following the month of purchase. Tony discussed the sales with the group. In discussions with potential customers, he realized they were cash Strapped themselves. They would gladly take the goods on consignment, but if Great Adventures required a sale, they would need at least 30 days pas the month of sale to pay. Tony didn't want to get into a consignment arrangement, so he agreed to the terms. Things were coming together. . General and Administrative Budget: Ending 12-31-2021 The actual products cost data for three months ending 12-31-2021 was as follows: Actual Sales in Units October November December 800 1200 2500 Officers Salaries Office Salaries Payroll Tax Indirect Labor Rent Utilities Depreciation Selling & Aministrative Selling & Administrive Fixed Interest Expense Insurance Office Supplies $ 15,250.00 $ 1,850.00 $ 6,840.00 $ 32,500.00 $ 6,250.00 $ 1,875.00 2 $3 per unit $ 8,500.00 ? ? $ 9,250.00 $ 1,850.00 Product Standards Standard Quantity Standard Price or Rate Standard Cost or Hours Direct Materials Fabric Metal Gromets Plastic Buckles Velcro 2.75 yards 12 13 1.5 yard $ $ $ $ $ 3.50 $ 0.50 $ 0.75 $ O.BS $ 6.25 6.00 21.00 0.75 Total Standard Cost Per Unit of Material $ 34.00 Direct Labor 5.5 hours $ 17.50 $ 81.00 Variable Manufacturing Overhead 4.5 hours $ 3.50 11.25 Three months of actual operations went by fast! The group now had time to evaluate operations and make some decisions. Things were pretty rocky for the first three months of their business, and they decided to fund any production needs from their savings during their growth phase of the business. However, they knew this could not continue and were intending on presenting their business plan to First National with the line of credit to be available at the first of the year. Covering their first full year of business. Suzie met with Mrs. Cheryl Biggs Business Lending Manager at First National Bank and had a very nice conversation: Mrs. Biggs: How are you financed currently? Suzie: Well, each of the founders put in $10,000 of their own funds. We also borrowed an additional $10,000 in unsecured loans from our parents. Any additional shortfalls come out of our collective savings. The loans are at 6% and are due in five years. Mrs Biggs: What do you think your financing needs will be from us? Suzie: We're looking for $100,000 dollars as a working capital loan. We would intend to access principle as needed. Total Unit Product Costs $ 126.25 Actual General & Administrative Costs were as follows: Mrs. Biggs: Well, we've done this type of loan for similar businesses, so we believe we can help. However, we're going to need some information. Based on your first three months of business When Suzie got back to her home office, she dug right in making phone calls and researching the business environment. She put together what she believed would be a reasonable general and administrative budget. Andrea indicated she would like to invest in a new cutting/sewing automated system. The piece of equipment would reduce manufacturing direct labor by 50%. It would also reduce material costs by 15% saving on waste. Tony loved the idea saying that he could increase sales by 10% because the total price point would be lowered by the savings. The machine would cost $150000. It would require the use of working capital of $25000 to start but this would be returned at the end of the useful life. The machines useful life would be 6 years. In order to make this investment, the bank would require: 1.) Budgets as follows: (See Chapter 8) a. Sales Budget b. Production Budget c. Direct Materials Budget d. Direct Labor Budget e. General and Administrative Expense Budget f. Cash Budget 2.) Variable Cost Income Statement 3.) Flexible Budget 4.) Breakeven level in units and dollars see chapter 2/3 5.) Margin of Safety See chapter 2/3 6.) Degree of Operating Leverage See Chapter 2/3 7.) For any new equipment purchases we would issue a separate loan but would need a net present value analysis and a payback analysis. (See Chapter 7) 8.) Terms of the line of credit would be at 12% with interest paid monthly on outstanding balances. Draws would need to be made in increments of $1,000. 1.) A positive NPV using the loan rate of 12% 2.) A payback not to exceed the useful life of the machine (See Chapter 7) Once the loan is approved, we of course will have some covenants needed to be adhered to related to variances between your actual activity and budgeted activity. Suzie considered this information and indicated she will get back to Mrs. Biggs with the Information Requested. She knew she had a lot of work to do. Tony is still struggling with the price point. He understands that Manufacturing Overhead will be assigned to the product on the basis of direct labor hours. He wants to consider a more meaningful allocation method. Doing a little research on his own, he discovered that an activity-based allocation method might be a better allocation method, particularly given that the new machine will reduce labor cost and may no longer be an accurate driver. Currently Great Adventures uses a plantwide overhead. Manufacturing Overhead Consists of Variable Costs Estimated to be $150,000 per year variable manufacturing costs allocated on the basis of direct labor hours. And $48,500 of fixed manufacturing overhead See Chapter 4 The actual sales for the first quarter of 2022 were as follows: Actual Sales in Units First Quarter 2022 Tony would like to switch to the following activity base drivers January February March 2600 2200 2300 Customer Orders Product Design Order Costs Set Up Requirements: Tony estimated the pools would consist of the following: Based on the information provided in the case: ACTIVITY BASE Customer Orders Product Design Machine Set Ups Order Size $ $ $ $ 375,000 Number of orders 22,500 Number of Designs 675,000 Number of Set-Ups 427,500 Machine Hours 1,500 50 2,500 75,000 $ 1,500,000 1.) Sales budget quarter ending in 2021 2.) Production budget Quarter Ending in 2021 3.) Direct materials Budget Quarter Ending in 2021 4.) Direct Labor Budget Quarter Ending in 2021 5.) Manufacturing Overhead Budget Quarter Ending in 2021 6.) Actual-Flexible-Planning Income Statement w/ Variance 7.) Direct Material Price and Quantity Variances 8.) Direct labor rate and efficiency variances 9.) Variable Overhead Rate & Efficiency Variances 10.) Net Present Value Analysis 11.) Make or Buy Analysis See Chapter 5 Suzie had another suggestion. There is a Filipino company that had contacted he regarding opportunity to offshore the manufacturing operations. The company offered to produce the backpack design and sell the unit back to the Great Adventures at: $125 a unit See chapter 6 Provide a comment on the viability of Great Adventures based on the information above. Make any recommendations for price or cost adjustments