Holstein Corporation12: PART I

In mid-November 2018, Bob, Paul and Cherry were almost through with the 2018 operating budget for their company, Holstein Corporation. Holstein produced milk products in three primary forms (yogurt, cheese and ice-cream). The industry was dominated by Milksted, Laughingcow, Happycow, and Holstein, which made several of types of milk products. Holstein was a small player in the industry with solid customer base and a profitable business over last few years. This year was a little different - their profit was significantly lower than the prior years. The company's proforma financials are provided in Exhibit 1.

The company produces 3 products. The standard costs for these three products are provided in Exhibit 2. The selling, general, and administrative (SG&A), other costs, interest income, and interest expense were likely to remain the same no matter which product-line combinations are used by the company.

The company hires your services as their consultant. They believe that they can improve their bottom-line (net profits) by changing the product mix, pricing and advertising decisions. (Note: The total production capacity is fixed at 420,000 units).

If the company decreases the price of its product, the result would be an increase in the sales of the product; the company provides you the following information on the estimated increase in the sales (based on the research by their sales team).

Ice-cream

Cheese

Yogurt

Decrease in Price

$1.60

$1.10

$0.75

Increase in sales

25,000

20,000

12,000

1 Part I and II should be solved independent of each other.

2 This case is partly adopted and modified from Cases in Managerial and Cost Accounting, Cambridge Business Publishers.

Given that the plant currently runs at full capacity, examine the following independent scenarios:

1. Calculate the contribution margins of each product (provide both - unit and total contribution margins)

2. What is the effect of discontinuing yogurt and using that production facility to produce cheese

3. What is the effect of decreasing the price of yogurt? If the decrease in price results in an increase in the

sale of yogurt, which product will you ask the management to produce less units of (considering fixed capacity)

4. Calculate the net change in profits if the company focuses more on advertising their ice-cream instead of cheese. Such an action would result in decrease (increase) unit sales of cheese (ice-cream) by 10,000 units.

5. Given the production capacity constraint, provide the most profitable product-mix.

Exhibit 1

Holstein Corp.

Proforma Statement 2018: Draft 12/31/2018

Sales

Less: costs of products sold Gross margin

SG&A

Other Fixed costs

Other costs

Operating income

Less: Interest expense Plus: Interest income Income before tax

Income taxes

Net income

$4,480,000 2,150,092 $2,329,908 193,500 1,458,108 22,150 $656,150 74,000 7,800 $589,950 206,483 $383,468

Exhibit 2 Holstein Corp.

Standard Costs of each product

Ice-cream

Cheese

Yogurt

Notes

Planned units

105,000

125,000

190,000

Per unit

Sales price

$16.00 $11.00 $7.50

Direct costs:

Materials

2.25

1.25

0.75

directly related to volume

Labor

2.5

2

1.5

directly related to volume

Subtotal

$4.75

$3.25

$2.25

Indirect cost:

Supplies

0.8

0.4

0.2

directly related to volume

Labor

2.1

1.8

0.8

three-fourth varies with direct labor, the rest is fixed

Energy

1

0.8

0.48

two third varies with direct labor, the rest is fixed

Supervision

0.8

0.5

0.1

unrelated to volume

Depreciation

1.6

1.2

0.5

unrelated to volume

Accounting/Legal/IT support

1.2

0.8

0.6

unrelated to volume

Other Fixed Costs

1.1

0.8

0.4

unrelated to volume

Exhibit 3

Actual 2018 Volume & Price

Ice-cream

Cheese

Yogurt

Price

$16.00

$11.00

$7.50

Volume

105,000

125,000

190,000

PART II

Mr. D.H. Perkins, VP of Marketing, advises you that he is interested in expanding the production of yogurt by adding a range of 3 flavored yogurts. He is confident that he can sell flavored yogurt at a 50% price premium to plain yogurt. He has collected the following data and he would like your help in determining the best course of action.

Additional variable processing cost for flavor mixing Materials cost - flavors and flavor stabilizers Purchase of new processing line machinery

Annual membership fee - Iowa Chocolate Council

$0.75 per unit

$0.95 per unit

$200,000 including installation $20,000

The new machinery is expected to be highly efficient, but its expected useful life is only 8 years, after which it will be scrapped. Salvage value is just 5% of the initial purchase price (including installation).

Q1. What would you recommend to Mr. Perkins and why? 10 points

Q2. Mr. Perkins also mentions that Mr. Jean St. Pierre, the President of the Iowa French-American Association, has advised him that there are a large number of French people in Iowa and other states who like the taste of yogurt made from unpasteurized milk. While it is allowable to sell unpasteurized milk in France, US Federal law does not allow it due to consumer safety concerns. The maximum penalty for selling unpasteurized dairy products is $25,000.

Mr. Pierre has advised Mr. Perkins that he himself would pay a premium of at least 100% for unpasteurized yogurt, and he is confident that the Iowa market size would be at least 30,000 units per year and the US as a whole would be at least 200,000 units per year.

Mr. Perkins has determined that Holstein would save $0.11 (power consumption and labor) per unit from skipping the pasteurization process. However, a new processing line would be required. The new machinery would cost $150,000 and its expected useful life would be 15 years, after which it will be scrapped. Salvage value is expected to 10% of the initial purchase price (including installation).

What would be your advice to Mr. Perkins? Why? - 10 points