It is April 2021 and you, an aspiring CPA, have just met with john. John has setup and is the current owner of a bike manufacturing company, Vaughan Bikes Inc. (VBI) is based out of Ottawa ON, and is looking for advice on the companys strategic direction going forward.

VBI was founded a number of in 2015 when, following her passion, John was taught by her mum how to make bicycle frames from scratch. John started out making bikes for friends and family, and was surprised to discover that they loved the product she was creating. She pursued this further by starting her own bicycle business out of a small industrial shop in her hometown. As VBI grew, John tried to ensure that the business stays true to its vision, mission, and values, outlined in Appendix I.

The companys bicycles are called Fordd and initially started of with just one type of bicycle. As time went on John was able to develop a and VBI now makes three models of Fordd - Standard, Performance and Elite. All of the models were designed to exploit the unique metal machining techniques originally developed by John. In addition to complete bicycles, the company also sells Elite frame sets - units that comprise only a frame and fork, with no added components.

Unique features of the Fordd include light-frame tubing and the ability to use tires as wide as 7.5 centimetres on 74-centimetre rims. The large diameter and extremely wide tires roll over obstacles more easily and provide greater stability in sand and snow.

Customer feedback has been extremely positive. On the companys blog, Fordd owners frequently comment that the bikes offer amazing value relative to their prices, which have not increased since the bikes were introduced five years ago. However, some Fordd fans have speculated that it is just a matter of time before an offshore bicycle maker notices the appeal of Fordd and introduces an even cheaper substitute. John has not patented her designs due to the upfront expense, and she feels that it is too easy to circumvent a patent and therefore not worth the money.

Despite operating at capacity, VBI is experiencing losses and cash flow problems (see Appendix II). John told you that she has just talked to her banker about securing additional funding for VBI to support the expected growth, and that the bank will not increase VBIs operating line of credit at ther time. However, because of the steady stream of orders and customer accolades, John believes that the market will continue to expand and that, ultimately, she will be very successful.

From a strategic standpoint, John sees three potential options for her business:

1. Organic growth: Increase current capacity and grow organically, maintaining the core of the business as is (Appendix III).
2. Retail store agreement: Begin selling to big-box retail stores. Two chain stores are interested in retailing VBIs products (Appendix IV).
3. Mountain High Bikes partnership: Partner with a similar company to expand the business. John has identified a potential opportunity with Mountain High Bikes, a similar company that has additional capacity (Appendix V).

John has realized that before making a decision, she needs to consider the riskiness of each alternative and its forecasted profitability. John would like you to analyze each of the three alternatives from both a qualitative and quantitative perspective. Next, John would like you to consider the fit of each alternative with VBIs vision, mission, and values, and provide an overall recommendation for VBI based on your complete analysis.

John would like to earn a rate of return of approximately 10%.

Your response should be no longer than 2,400 words, excluding any Excel files.

Appendix I VBIs vision, mission, and values

Vision

To be an iconic provider of high-quality, Canadian-made bikes.

Mission

To continuously deliver value to customers by:

• manufacturing and delivering high-quality bicycles at reasonable prices
• using innovative materials to create a product that our competitors cant match
• employing sustainable business practices that respect our natural environment

Values

• Commitment to customer satisfaction: We will put the needs of our customers first to deliver the ultimate in value and consumer happiness.
• Respect for our employees: We will ensure our employees feel valued and treated with respect at all times by providing a safe and enjoyable working environment.
• Family owned and operated: We will keep the business in the family, and as a family-run business we will take pride in the products we manufacture.
• Committed to community: We will never forget where we were founded, and we will always look for ways to give back to the community that has helped us grow.

Appendix II VBI financial information

Production data and income statement (unaudited) For the 12 months ending June 30, 2020 Revenue and costs per unit

	Standard	Performance	Elite	Elite Frame set	Total
Hours available1	2,450	1,750	525	750
Direct labour hours/unit	35	35	35	30
Revenue
Unit price	$1,800	$2,450	$2,750	$1,350
Cost of goods sold per unit
Frame tubing	160	160	300	300
Parts kits	855	1,300	1,800	-
Materials2	40	40	75	75
Direct labour cost	700	700	700	600
Overhead cost3	70	70	70	60
Gross margin/unit	$(25)	$180	$(195)	$315
Units sold	70	50	15	25
	(1,750)	9,000	(2,925)	7,875	12,200
Selling costs4					4,500
General and admin expenses5					19,500

Pre-tax profit (loss)

$(11,800)

Notes:

1. John and Sandra are currently working at capacity, and total labour hours worked cannot be increased.
2. Consists of paint, clear coat, and decals.
3. Small parts, maintenance, and so on are applied on the basis of direct labour hours. Assume all costs are variable.
4. Includes costs for website hosting, utilities, travel to bike trade shows, and so on.
5. Includes interest, Diane Shackeltons salary, and so on.

Appendix III VBI operations and organic growth

Employees

Diane Shackelton (Johns wife) works part time as the order taker/bookkeeper at a salary of $14,000 per year. Diane is risk averse and looking to support her husband while making stable decisions for her family.

Sandra Cullen is the only other employee. She is an experienced metalworker and is Johns indispensable assistant.

Bike production

The main appeal of the Fordd is the careful attention VBI pays to all details of production. It is Johns policy to inspect and sign each frame personally to denote its authenticity. John and Sandra are currently working full-time with no additional capacity. John and Sandras working hours are the bottleneck in production and are the main constraint.

John believes that the production hours required per bike could be reduced by 40% if VBI created a more efficient workspace and segregated tasks that are not directly related to manufacturing. VBI would need to double the shop space as well as hire a third employee for tasks such as unpacking inventory and cleaning up the shop. Early indications are that John could lease a building with double the space for an additional $1,000 per month. The cost of a third employee is estimated to be $2,000 per month. Moving to a new location and expanding production would require a significant cash infusion.

Although VBI has only used a website and word of mouth as marketing tools, John and Sandra have been overwhelmed by the number of orders VBI receives. Given the built-up demand for Fordd, John feels that its time to increase the price by 10%. Even with the price increase, John estimates VBI would be able to sell as many bikes as it can produce.

Appendix IV Retail store agreement

The retail store agreements being considered by John include the following five-year contracts:

• Specialty bicycle retailer: Contract to purchase 500 Elite frame sets each year at a price of $550 each
• Sporting goods chain: Contract to purchase 1,000 Standard and 1,000 Performance bikes each year at $1,200 (Standard) and $1,650 (Performance) each

In order to reduce costs and produce the volumes required, John would need to outsource Fordd production to China. Chinese manufacturers could make each model for the following costs: Standard: $1,100, Performance: $1,500, and Elite frame sets: $400 (including the cost of freight to deliver to the retailers). Business practices employed and manufacturing processes are at the discretion of the Chinese manufacturer.

John would continue to assemble the Ultra model himself in order to stay busy. She estimates that she and Sandra could build 155 Elite bicycles and sell them to customers at the existing price of $2,750 per bike. They would use VBIs existing facilities to do ther.

John does not believe the agreement will be renewed after the five-year period. She has heard that once the products are manufactured in China, designs are likely to be copied, and therefore competitors will likely enter the market offering lower prices that VBI will be unable to compete with. If VBI pursues this option, John plans to close the business after the five-year contract period.

Appendix V Mountain High Bikes partnership

Mountain High Bikes background

Mountain High Bikes (Mountain High) is a small manufacturer based out of Kelowna, BC, that produces high-performance mountain bikes and sells them through specialty bike shops in Canada. Mountain High is doing well, but the owner, Laurie King, would like to increase the breadth of the companys product line by entering into a partnership with VBI.

Production facility

Although the production processes and materials for the two bicycle companies are different, Laurie is willing to provide some financing for the expansion plans and share her modern production facility, which is located in the same city as VBI.

Under the terms of the proposed agreement, Laurie would maintain VBIs overhead costs at $2/direct labour hour as well as help VBI gain a foothold in specialty bike shops across Canada. Laurie is confident that the access to improved production equipment and paint facilities would reduce the direct labour hours by 50% from current. Additionally, Diane would no longer need to be paid by VBI. Mountain High would maintain the same labour constraint as currently exists at VBI due to their other production commitments. John would still plan to implement a 10% increase in the price of all bicycles under ther option.

Compensation to Mountain High

Under the arrangement with Mountain High, John would transfer 10% of the ownership in VBI to Laurie in each of the five years of the agreement; at the end of the five-year period, Laurie would own 50% of VBI and share equally in the business and its profits.