home / study / business / accounting / questions and answers / question: case #3 arizona microbrewery, inc. in ... Question: Question: Case #3 Arizona Microbrewery, Inc. In 20... Bookmark Question: Case #3 Arizona Microbrewery, Inc. In 2009, David ... Bookmark Case #3 Arizona Microbrewery, Inc. In 2009, David Stott quit his job at a large beer company to start his own brewery, Arizona Microbrewery, Inc. (AMI). His family supported his decision and invested in the business along with David. AMI started operations on January 10, 2010 and produces four labels of specialty beers (Saguaro Pale Ale, Bisbee Bock, Ocotillo Amber Pilsner and Sedona Stout). An explanation of the beer making process is shown in Appendix A. In much of the United States (including Arizona), beer is sold in a three-tier system. Under this system, beer is manufactured by producers, sold to distributors who then sell to retailers (such as liquor stores, drug stores, grocery stores, etc.). David employs two salespeople who receive a fixed monthly salary plus an 8% commission. All beer is sold in cases of 24 bottles to beer distributors (primarily in the Southwestern United States). Product sales and cost information for 2013 is shown in Exhibit 1 with additional information in Exhibit 2. David rents a facility which is used to make the beer, a refrigeration area to store the beer and a small office area. AMI brewery has 5 machines with 9,300 total machine hours available per year to produce beer (assuming they remain on one shift with some normal maintenance, breaks, etc.). While there is an empty space in the facility that could be used to expand the beer operations, the company would need to purchase an additional grain hopper and brew house for about $100,000 (the current water system and process control system could be expanded to handle the new machine). As discussed in Appendix A, beers are aged in a refrigeration area prior to sale. The current refrigeration unit allows for different temperatures in different areas of the unit and the unit is usually running about 80% full. Keeping the refrigeration unit somewhat full helps reduce refrigeration costs. Additionally, since the company is so new, sales have been growing but erratic (from 2010 to 2011, sales growth was over 45%; however, from 2012 to 2013, sales growth was only 12%). Thus, keeping more beer on hand allows the company to meet the erratic demand without loss of sales. David has not taken a salary since the business started. While the business has been generating a small profit, David has been reinvesting earnings back into the business. He wants to grow the business to generate more profit for him and for his family. David has been considering increasing the price on Sedona Stout to $29.00 per case. He thinks that, with this price increase, unit sales will decrease to 3,750 cases per year. However, this would reduce total Stout revenues from $110,876 to $108,750. Alternatively, David could drop the price of Sedona Stout to $25 per case. Based on his market research, he thinks that this will result in sales increasing to 4,700 cases. He is leaning towards this alternative as this will increase Stout revenues from $110,876 to $117,500. While the company has some cash on hand, neither the company nor Davids family have another $100,000 to invest in the business right now. Since the business is new and has been showing only small profits, David has not been able to get a loan to expand the business. Instead, David wants to fully utilize the machines they have (with 9,300 total machine hours available during the year). In 2013, they used a little over 8,300 machine hours (as shown in Exhibit 1). David wants to keep producing and selling all four product lines as many of the beer distributors like buying from breweries with several different beers. However, he wants to direct the salespeople to emphasize a certain product when they are out talking with beer distributors. Given the current machine setup, David is not sure what beer product line to tell the sales people to emphasize to maximize his profits. Finally, David and his family love root beer. Root beer follows a somewhat similar process to beer in that the ingredients are mixed together to form a "culture" that then goes through fermenting, filtering and filling. Root beer would not need to be aged or stored in the refrigerator. There is an empty area in the current microbrewery facility that could be dedicated to making root beer. As a result, David has been talking with his family about producing and selling a line of specialty root beer. Root beer would be produced on different machinery. Davids sister knows someone who is getting out of the soda business and would be willing to sell them the machinery needed to make the root beer for $8,000. Based on market research he has done, David thinks that he could charge $16.50 per case of root beer. Based on the same research he also thinks that he could sell between 3,000 and 12,000 cases of root beer with likely sales of about 6,000 cases. Root beer could be sold to some of his current distributors. However, soda does not need to be sold through the three-tier system required for alcohol sales. Therefore, much of root beer sales would be directly to upscale groceries such as La Grande Orange Grocery and Pizzeria in Phoenix and Whole Foods and AJ's Fine Foods with locations throughout Arizona. David could produce the root beer in-house or out-source production. David has talked with another company who could produce the root beer for AMI using Davids recipe and AMI could sell it as their brand (this option is referred to as private label). It could be purchased from this other company for $13.05 per case. AMI would still need to incur some variable handling costs and some minor fixed costs. Alternatively, AMI could produce the root beer in house. See Exhibit 3 for estimated cost information. QUESTIONS You have been hired as a consultant to help David with the business. Please address the following questions in preparation for your discussions with David. Ignore any current plans. In question one, you identified the total number of cases the company needs to sell to earn $50,000 after tax (and how many cases for each product line). Assume you did the calculations in question one correctly. However, before discussing your solution with the owner, identify and explain at least three issues related to your analysis and the assumptions employed in your analysis in question 1(discuss each concern; what it is and why it is a concern; do NOT just question general facts of the case such as why we are charging so little for one product or another). Refer to the original data. David has a few options regarding Sedona Stout pricing: a) keep the sales price the same (no change), b) increase the sales price or 3) decrease the sales price. What would you recommend he do and why? Provide both quantitative and qualitative analysis. Next, ignoring the Sedona Stout information, consider David's question regarding what product line the sales people should emphasize. David wants the sales efforts to maximize profits and utilize the companys current capacity. What would you tell him? Explain your rationale. Analyzing the sales forecast of root beer, what preliminary course of action do you recommend (in- house or out-source production) and why? Support your recommendation with numbers. What other issues, concerns or further analysis do you want to discuss with David? Your issues/concerns could pertain to the out-sourcing decision as well as whether AMI should add root beer as a new product line. The issues/concerns should include both numeric and non-numeric issues. Do NOT just bullet point all kinds of items; instead, talk about specifics and how they relate to this company/situation and why it is important to consider. Beer Making Process Beer is the overall generic term for fermented malt beverages. There are only two kinds of beer ales and lagers. Within those two broad categories there are many styles. Major ale styles are pale ale, IPA, porter, stout, and barleywine. Among the major lager styles are pilsner, Mrzen, bock, and dunkles (dark lager). AMI makes two ales (Saguaro Pale Ale and Sedona Stout) and two lagers (Ocotillo Amber Pilsner and Bisbee Bock). It is the yeast that is a significant difference between the ale and the lager. Ale yeasts coagulate loosely at the top of the fermentation tank. Given the type of yeast, ales ferment best between 64 to 70 degrees Fahrenheit. Lager yeasts are more successful at colder temperatures, typically 50 to 55 degrees Fahrenheit and coagulate closer to the bottom of the fermentation tank. Lager yeasts also tend to ferment more aggressively, leaving behind less residual sweetness and flavor than ales. DIRECT MATERIALS: Beer primarily consists of 4 ingredients: water, barley, hops and yeast. A clarifying agent is also used in the beer making process. The different types of beer require different proportions of these ingredients and even slightly different ingredients (e.g. Pale Ale uses a pale malted barley while Stout is made using a darker roasted barley.). BREWING PROCESS: Work in the brewery is typically divided into 8 steps: Mashing, Lautering, Boiling, Fermenting, Conditioning, Filtering, Filling and Aging. Mashing: Mashing is the first process in brewing. The barley grains are mixed with water. This mixture is heated up with rests at certain temperatures to allow enzymes in the malt to break down the starch in the grain into sugars. Lautering: Lautering is the separation of the extracts obtained during mashing to create Wort. Lautering has two stages: first Wort run-off, during which the extract is separated in an undiluted state from the spent grains, and sparging in which extract which remains with the grains is rinsed off with hot water. The result of this process is a dark, sugar heavy liquid called Wort. Boiling: Boiling the Wort ensures its sterility and prevents infection. During the boil, hops are added, which contribute their bitterness, aroma and flavor compounds to the beer. The boil must be conducted so that it is even and intense. The boil lasts between 60 and 120 minutes, depending on its intensity, the hop addition schedule and the volume of Wort expected to evaporate. The Wort is then cooled before fermentation. Fermenting & Conditioning: Fermentation starts as soon as yeast is added to the cooled wort. This is also the point at which the product is first called beer. It is during this stage that fermentable sugars are metabolized into alcohol and carbon dioxide (the bubbles in beer). As noted above, fermentation temperatures are very different for ales versus lagers. When the sugars in the fermenting beer have been almost completely digested, the fermentation slows down and the yeast cells will naturally start to die off and begin to settle towards the bottom of the tank at an accelerated rate. At AMI, the fermentation tanks have cooling jackets on them. Therefore, conditioning can take place in the same tank as fermentation. Beer Making Process (Continued) Filtering: Filtering the beer stabilizes flavor, and gives beer its shine. Filters remove much of the yeast and any solids (e.g. hops, grain particles) left in the beer. Filling: (a.k.a. "packaging") is putting the beer into the bottles in which it will leave the brewery. At this point, carbon dioxide is infused in the bottling process to increase the carbon dioxide in the beer. Cases of beer (consisting of 24 bottles) are then put into aging. Aging: Beer is stored (aged or "lagered") in the refrigerator unit and the temperature and length of the aging will vary based on the type of beer. Ales are usually aged no more than a few weeks. The aging process is generally done at 40 to 55 degrees Fahrenheit. Lagers are similarly aged but at much lower temperatures, 32 to 45 degrees Fahrenheit, and for a much longer time typically months. This is called lagering and creates a cleaner, clearer beer. The refrigeration unit allows for different temperatures in different areas of the unit. 2013 COST & SALES INFORMATION Per Case Information: Ocotillo Saguaro Bisbee Amber Sedona Sales Price per case Pale Ale $ 21.00 Bock $ 24.50 Pilsner $ 23.50 Stout $ 26.50 Total Direct Materials per case 2.75 2.90 3.15 4.00 Direct Labor per case 3.75 3.75 3.00 5.25 Variable Overhead per case 5.90 6.18 6.10 6.34 Total VC per case 12.40 12.83 12.25 15.59 Contribution Margin per Case $ 8.60 $ 11.67 $ 11.25 $ 10.91 Cases sold last year 12,593 7,126 6,827 4,184 30,730 DLH per case 0.25 0.25 0.20 0.35 Total DLH last year 3,148.25 1,781.50 1,365.40 1,464.40 7,759.55 MH per case 0.20 0.40 0.25 0.30 Total MH last year 2,518.60 2,850.40 1,706.75 1,255.20 8,330.95 Contribution Margin Income Statement: Ocotillo Saguaro Pale Ale Bisbee Bock Amber Pilsner Sedona Stout Total Sales $264,453.00 $174,587.00 $160,434.50 $110,876.00 $710,350.50 Variable Costs 156,153.20 91,426.58 83,630.75 65,228.56 396,439.09 Contribution Margin 108,299.80 83,160.42 76,803.75 45,647.44 313,911.41 Direct Fixed Costs 10,329.62 8,392.91 6,017.39 9,893.92 34,633.84 Segment Margin $97,970.18 $74,767.51 $70,786.36 $35,753.52 $279,277.57 Common Fixed Costs $245,389.44 Operating Income $ 33,888.13 Taxes (35%) 11,860.85 Net Income $ 22,027.28 ADDITIONAL COST INFORMATION Details of Total VC Direct Materials $ 93,537.20 Direct Labor 116,393.25 Production Supplies 26,064.41 Variable portion of Maintenance 40,892.55 Variable portion of Utilities 27,610.57 Variable Office Supplies (sales forms, etc) 3,493.88 Shipping costs 31,619.19 8% Sales Commission 56,828.04 Total Variable costs $396,439.09 Details of Total Fixed Costs (direct and indirect) Brew Master / Quality Control manager 60,293.15 Receiving and Shipping department expenses 22,511.32 Depreciation 11,712.10 Facility costs (rent, taxes, insurance, etc) 78,938.15 Advertising & Marketing costs 22,994.91 Fixed portion of Maintenance (including IT support) 9,992.98 Fixed portion of Utilities (including refrigeration) 10,390.37 Fixed portion of Office Supplies 4,305.66 Fixed Salary of Salespeople 32,221.81 Administrative staff to assist owner 26,662.83 Total Fixed Costs $280,023.28 ROOTBEER COST INFORMAITON Alternative 1 - Produce In-House Direct Materials per case 1.75 Direct Labor per case 2.25 Variable Overhead per case 3.60 Total Variable costs per case 7.60 Additional Fixed costs (per year) $ 37,640 (These are recurring costs and does not include the purchase of the machine) Alternative 2 - Outsource Production Purchase price per case 13.05 Variable Overhead per case 0.10 Total Variable costs per case 13.15 Additional Fixed costs (per year) $ 6,000

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