EXHIBIT 2 Data Pertinent to Hi-Valu Proposal Notes Taken by Suzanne Leister 1. Estimated first-year costs of producing Challenger bicycles (average unit costs, assuming a constant mix of models): Materials 539.80 Direct labor 19.60 Overhead (@125% of direct labor) 24.50 583.90 Includes items specific to models w a t di e meel Accountant says about 40 percent of total productio n is 125 percent of DLS role is based on volume of 100 b les per you 2. One-time added costs of preparing drawings and/or arranging sources for fenders, seats, handlebars, tires, and shipping boxes that differ from those used in our standard models: approximately 55,000 (based on estimated two person-months of effort at $2,500 per month). 3. Unit price and annual volume: Hi-Valu estimates it will need 25,000 bikes a year and proposes to pay us (based on the assumed mix of models) an average of $92.29 per bike for the first year. Contract to contain an inflation escalation clause such that price will increase in proportion to inflation-caused increases in costs shown in item 1. above; thus, the 592.29 and 583.90 figures are, in effect, "constant-dollar" amounts. Knott intimated that there was very little, if any, negotiating leeway in the 592.29 proposed ini tial price. 4. Asset-related costs (annual variable costs, as percent of dollar value of assets): Pretax cost of funds (to finance receivables or inventories) 11.5 Recordkeeping costs (for receivables or inventories) 2.0 Inventory insurance State property tax on inventory Inventory-handling labor and equipment Pilferage, obsolescence, damage, etc. 5. Assumptions for Challenger-related added inventories (average over the year): Materials: two months' supply. Work in process: 1,000 bikes, half completed (but all materials for them issued) Finished goods: 500 bikes (awaiting next carload-lot shipment to a Hi-Valu warehouse) 6. Impact on our regular sales: Some customers comparison shop for bikes, and many of them are likely to recognize a Challenger bike as a good value when compared with a similar bike (either ours or a competitor's) at a higher price in a nonchain toy or bicycle store. In 1988, we sold 98.791 bikes. My best guess is that our sales over the next three years will be about 100,000 bikes a year if we forgo the Hi-Valu deal. If we accept it, I think we'll lose about 3,000 units of our regular sales volume a year, since our retail distribution is quite strong in Hi-Valu's market regions. These estimates do not include the possibility that a few of our current dealers might drop our line if they find out we're making bikes for Hi-Valu. 0.6 store. At that point, Hi-Valu would regard the bicycle as having been purchased from Baldwin, and would pay for it within 30 days. However, Hi-Valu would agree to take title to any bicycle that had been in one of its warehouses for four months, again paying for it within 30 days. Mr. Knott estimated that on average a bike would remain in a Hi-Valu regional warehouse for two months. Second, Hi-Valu wanted to sell its Challenger bicy. cles at lower prices than the name-brand bicycles it carried and yet still earn approximately the same dollar gross margin on each bicycle sold-the ratio- nale being that Challenger bike sales would take away from the sales of the name-brand bikes. Thus, Hi-Valu wanted to purchase bikes from Baldwin at lower prices than the wholesale prices of comparable bikes sold through Baldwin's usual channels Finally, Hi-Valu wanted the Challenger bike to be somewhat different in appearance from Baldwin's other bikes. While the frame and mechanical components could be the same as used on current Baldwin models the fenders, seats, and handlebars would need to be Chapter 26 Short-Run Alternative Choice Decisions 839 Suzanne Leister realized she needed to do some preliminary financial analysis of this proposal be- fore having any further discussions with Karl Knott. She had written on a pad the information she had gath- ered to use in her initial analysis, this information is summarized in Exhibit 2. Questions amewhat different, and the tires would have to have the name "Challenger" molded into their sidewalls. Also, the bicycles would have to be packed in boxes printed with the Hi-Valu and Challenger names. Ms. Leister thought that possibly these requirements would in- crease Baldwin's purchasing, inventorying, and pro- duction costs over and above the added costs that would be incurred for a comparable increase in volume for Baldwin's regular products. On the positive side, Ms. Leister was acutely aware that the "bicycle boom" had flattened out, and this plus a poor economy had caused Baldwin's sales volume to fall the past two years. As a result, Baldwin currently was operating its plant at about 75 percent of one-shift capacity. Thus, the added volume from Hi-Valu's pur- chases could possibly be very attractive. If agreement could be reached on prices, Hi-Valu would sign a con tract guaranteeing to Baldwin that Hi-Valu would buy its house-brand bicycles only from Baldwin for a three-year period. The contract would then be auto- matically extended on year-to-year basis, unless one party gave the other at least six-months' notice that it did not wish to extend the contract. 1. What is the expected added profit from the Chal- lenger line? 2. What is the expected impact of cannibalization of existing sales? 3. What costs will be incurred on a one-time basis only? 4. What are the additional assets and related carrying costs? 5. What is the overall impact on the company in terms of (a) profits, (b) return on sales, (c) return on as- sets, and (d) return on equity? 6. What are the strategic risks and rewards? 7. What should the company do? Why? EXHIBIT 2 Data Pertinent to Hi-Valu Proposal Notes Taken by Suzanne Leister 1. Estimated first-year costs of producing Challenger bicycles (average unit costs, assuming a constant mix of models): Materials 539.80 Direct labor 19.60 Overhead (@125% of direct labor) 24.50 583.90 Includes items specific to models w a t di e meel Accountant says about 40 percent of total productio n is 125 percent of DLS role is based on volume of 100 b les per you 2. One-time added costs of preparing drawings and/or arranging sources for fenders, seats, handlebars, tires, and shipping boxes that differ from those used in our standard models: approximately 55,000 (based on estimated two person-months of effort at $2,500 per month). 3. Unit price and annual volume: Hi-Valu estimates it will need 25,000 bikes a year and proposes to pay us (based on the assumed mix of models) an average of $92.29 per bike for the first year. Contract to contain an inflation escalation clause such that price will increase in proportion to inflation-caused increases in costs shown in item 1. above; thus, the 592.29 and 583.90 figures are, in effect, "constant-dollar" amounts. Knott intimated that there was very little, if any, negotiating leeway in the 592.29 proposed ini tial price. 4. Asset-related costs (annual variable costs, as percent of dollar value of assets): Pretax cost of funds (to finance receivables or inventories) 11.5 Recordkeeping costs (for receivables or inventories) 2.0 Inventory insurance State property tax on inventory Inventory-handling labor and equipment Pilferage, obsolescence, damage, etc. 5. Assumptions for Challenger-related added inventories (average over the year): Materials: two months' supply. Work in process: 1,000 bikes, half completed (but all materials for them issued) Finished goods: 500 bikes (awaiting next carload-lot shipment to a Hi-Valu warehouse) 6. Impact on our regular sales: Some customers comparison shop for bikes, and many of them are likely to recognize a Challenger bike as a good value when compared with a similar bike (either ours or a competitor's) at a higher price in a nonchain toy or bicycle store. In 1988, we sold 98.791 bikes. My best guess is that our sales over the next three years will be about 100,000 bikes a year if we forgo the Hi-Valu deal. If we accept it, I think we'll lose about 3,000 units of our regular sales volume a year, since our retail distribution is quite strong in Hi-Valu's market regions. These estimates do not include the possibility that a few of our current dealers might drop our line if they find out we're making bikes for Hi-Valu. 0.6 store. At that point, Hi-Valu would regard the bicycle as having been purchased from Baldwin, and would pay for it within 30 days. However, Hi-Valu would agree to take title to any bicycle that had been in one of its warehouses for four months, again paying for it within 30 days. Mr. Knott estimated that on average a bike would remain in a Hi-Valu regional warehouse for two months. Second, Hi-Valu wanted to sell its Challenger bicy. cles at lower prices than the name-brand bicycles it carried and yet still earn approximately the same dollar gross margin on each bicycle sold-the ratio- nale being that Challenger bike sales would take away from the sales of the name-brand bikes. Thus, Hi-Valu wanted to purchase bikes from Baldwin at lower prices than the wholesale prices of comparable bikes sold through Baldwin's usual channels Finally, Hi-Valu wanted the Challenger bike to be somewhat different in appearance from Baldwin's other bikes. While the frame and mechanical components could be the same as used on current Baldwin models the fenders, seats, and handlebars would need to be Chapter 26 Short-Run Alternative Choice Decisions 839 Suzanne Leister realized she needed to do some preliminary financial analysis of this proposal be- fore having any further discussions with Karl Knott. She had written on a pad the information she had gath- ered to use in her initial analysis, this information is summarized in Exhibit 2. Questions amewhat different, and the tires would have to have the name "Challenger" molded into their sidewalls. Also, the bicycles would have to be packed in boxes printed with the Hi-Valu and Challenger names. Ms. Leister thought that possibly these requirements would in- crease Baldwin's purchasing, inventorying, and pro- duction costs over and above the added costs that would be incurred for a comparable increase in volume for Baldwin's regular products. On the positive side, Ms. Leister was acutely aware that the "bicycle boom" had flattened out, and this plus a poor economy had caused Baldwin's sales volume to fall the past two years. As a result, Baldwin currently was operating its plant at about 75 percent of one-shift capacity. Thus, the added volume from Hi-Valu's pur- chases could possibly be very attractive. If agreement could be reached on prices, Hi-Valu would sign a con tract guaranteeing to Baldwin that Hi-Valu would buy its house-brand bicycles only from Baldwin for a three-year period. The contract would then be auto- matically extended on year-to-year basis, unless one party gave the other at least six-months' notice that it did not wish to extend the contract. 1. What is the expected added profit from the Chal- lenger line? 2. What is the expected impact of cannibalization of existing sales? 3. What costs will be incurred on a one-time basis only? 4. What are the additional assets and related carrying costs? 5. What is the overall impact on the company in terms of (a) profits, (b) return on sales, (c) return on as- sets, and (d) return on equity? 6. What are the strategic risks and rewards? 7. What should the company do? Why