Question: David is determined to make $50,000 after tax. After listening to your advice, he makes a radical choice: discontinuing the production of Bock and Stout beers. Assume that David has conducted some market research that shows he will continue selling Ale and Pilsner beer at a ratio of 2 to 1. Given Davids current productive capacity, can he now achieve his goal? How many cases of Ale and Pilsner would he have to sell to reach his goal? Given the 2:1 sales mix and the available number of machine hours, what is the maximum after-tax profit David could attain using this strategy?

Please show calculations

Case:

In 2009, David Tucker 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 began operations on January 10, 2010 and now 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, and grocery stores). David employs two salespeople who receive a fixed monthly salary plus an 8 percent commission. All beer is sold to beer distributors (primarily in the Southwestern United States) in cases of 24 bottles. Product sales and cost information for 2013 are shown in Exhibit 1 with additional information in Exhibit 2. David rents a facility that is used to make the beer, a refrigeration area to store the beer, and a small office area. AMI brewery has five machines with 9,300 total machine hours available per year to produce beer (assuming AMI remains 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 percent full. Keeping the refrigeration unit somewhat full helps reduce refrigeration costs.1 Additionally, since the company is so new, sales have been growing but erratic (from 2010 to 2011, sales growth was over 45 percent; however, from 2012 to 2013, sales growth was only 12 percent). 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 the earnings in the business. He wants to grow the business to generate more profit for his family and himself. David has been considering increasing the price on Sedona Stout from $26.50 per case to $29.00 per case. He thinks that, with this price increase, unit sales will decrease from 4,184 cases to 3,750 cases per year. However, this would only reduce total annual Stout revenues to $108,750 from $110,876. Alternatively, David could drop the price of Sedona Stout to $25 per case. This is much closer to the Bock price as well as the Pilsner. Based on his market research, he thinks that this will result in Stout sales increasing to 4,700 cases per year. He is leaning toward this alternative as this will increase Stout revenues from $110,876 to $117,500 per year. 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 for a new grain hopper and brew house. 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 already have. In 2013, they used a little over 8,300 machine hours (as shown in Exhibit 1) and the existing five machines have a total of 9,300 machine hours available during the year (assuming normal maintenance and some repairs needed during the year). Thus, the existing machines have approximately 1,000 additional hours available for use. David wants to keep producing and selling all four of his product lines because many of the beer distributors like buying from breweries that offer several different beers.

However, he wants to direct the salespeople to emphasize a certain product when they are out talking to the beer distributors. Given the current machine availability, David is not sure what beer product line to tell the sales people to emphasize in order 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 using different machinery rather than the existing five beer machines. Davids sister knows someone who is getting out of the soda business and would be willing to sell the used 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 market research, there is a lot of uncertainty in how many cases of root beer the company could sell. David is less familiar with the root beer market and there is a wide range in sales of specialty root beer in the local groceries. Based on his understanding of the market, he thinks he could sell between 3,000 and 12,000 cases of root beer per annum 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 that is 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 AJs Fine Foods with locations throughout Arizona. David could produce the root beer in-house or out-source the 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.

APPENDIX A

Beer-Making Process Beer is the overall generic term for fermented malt beverages. There are only two kinds of beer: ale and lager. Within those two broad categories there are many styles. Major ale styles are pale ale, India Pale Ale (IPA), porter, stout, and barleywine. Among the major lager styles are pilsner, Marzen, 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 the 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 four ingredients: water, barley, hops, and yeast. A clarifying agent is also used in the beermaking 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 eight steps: Mashing, Lautering, Boiling, Fermenting and Conditioning, Filtering, Filling, and Aging.

Mashing Mashing is the first process in brewing. The barley grains are mixed with water in a large vessel. This mixture is heated with periodic breaks, or rests, at certain temperatures to allow enzymes in the malted grains to break down the starch in the grain into sugars.

Lautering Lautering is when the mash is separated into a liquid and the residual grain. There are two stages to lautering. In the first stage, called Wort Run-Off, a liquid (or extract) is separated in an undiluted form from the used grains. The second stage is called sparging. During sparging, the extract that remains with the grains is rinsed off with hot water. The results of these two stages are combined and the result is a dark, sugary liquid called Wort. This is returned to the original Mashing vessel.

Boiling Boiling the Wort in the vessel ensures that the mixture is sterile and prevents infection. During the boiling step, hops are added to the Wort. The hops contribute bitterness, aroma, and flavor compounds to the beer. The boiling must be continuous and intense (rolling boil) and typically lasts between 60 and 120 minutes, depending on its intensity, when the hops are added and the amount of Wort expected to evaporate. The Wort is then cooled before the fermentation stage.

Fermenting and Conditioning The cooled Wort is put into a fermentation tank and yeast is added, which starts the fermentation process. 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. Fermentation takes about a week. 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 to the bottom of the tank. At AMI, the fermentation tanks are equipped with cooling jackets. Therefore, conditioning can take place in the same tank as fermentation. Conditioning (also called maturation) is when beer is cooled in the tanks to allow the yeast to settle to the bottom of the tank. Conditioning allows the flavor of the beer to become smoother and is a natural filtration process (removing cloudy material from the beer).

Filtering The beer that comes out of the fermentation tank must be filtered prior to bottling. Filtering the beer stabilizes flavor and gives beer its gloss or shine. Filtering removes much of the yeast and any solids (e.g., hops and other grain particles) that remain in the beer.

Filling The filling process (also called packaging) is putting the beer into the bottles in which it will leave the brewery. At this point, carbon dioxide is added to 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). Lagering creates a cleaner, clearer beer. The refrigeration unit allows for different temperatures in different areas of the unit.

EXHIBIT 1 2013 Cost and Sales Information Panel A: Per CaseInformation Ocotillo Pilsner $23.50 Bisbee Saguaro Pale Ale Sedona Stout oc Total $21.00 2.75 3.75 $24.50 Sales Price Direct Materials per case Direct Labor per case Variable Overhead per case Total Variable Cost per case S26.50 6.34 15.59 $10.91 12.25 Contribution Margin per Case $8.60 $11.25 Cases Sold last year 12,593 7,126 6,827 30,730 Direct Labor Hours per case Total Direct Labor Hours last year 0.25 1,781.50 1,365.40 0.25 1,706.75 0.35 1,464.40 0.30 1,255.20 3,148.25 7,759.55 Machine Hours per case Total Machine Hours last year 2,518.60 2,850.40 8,330.95 Panel B: Contribution Margin Income Statement Ocotillo Saguaro Pale Ale $264,453.00 156,153.20 $108,299.80 Bisbee Bock Sedona Stout Total $710,350.50 96,439.09 $313,911.41 34,633.84 $279,277.57 245,389.44 $33,888.13 11,860.85 $22,027.28 Pilsner $160,434.50 83,630.75 $76,803.75 Sales $174,587.00 $110,876.00 Variable Costs 91,426.58 65,228.56 Contribution Margin $83,160.42 $45,647.44 Direct Fixed Costs Segment Margin Common Fixed Costs Operating Income 10,329.62 8,392.91 6,017.39 9,893.92 97,970.18 $74,767.51 $70,786.36 35,753.52 Taxes (35%) Net Income EXHIBIT 1 2013 Cost and Sales Information Panel A: Per CaseInformation Ocotillo Pilsner $23.50 Bisbee Saguaro Pale Ale Sedona Stout oc Total $21.00 2.75 3.75 $24.50 Sales Price Direct Materials per case Direct Labor per case Variable Overhead per case Total Variable Cost per case S26.50 6.34 15.59 $10.91 12.25 Contribution Margin per Case $8.60 $11.25 Cases Sold last year 12,593 7,126 6,827 30,730 Direct Labor Hours per case Total Direct Labor Hours last year 0.25 1,781.50 1,365.40 0.25 1,706.75 0.35 1,464.40 0.30 1,255.20 3,148.25 7,759.55 Machine Hours per case Total Machine Hours last year 2,518.60 2,850.40 8,330.95 Panel B: Contribution Margin Income Statement Ocotillo Saguaro Pale Ale $264,453.00 156,153.20 $108,299.80 Bisbee Bock Sedona Stout Total $710,350.50 96,439.09 $313,911.41 34,633.84 $279,277.57 245,389.44 $33,888.13 11,860.85 $22,027.28 Pilsner $160,434.50 83,630.75 $76,803.75 Sales $174,587.00 $110,876.00 Variable Costs 91,426.58 65,228.56 Contribution Margin $83,160.42 $45,647.44 Direct Fixed Costs Segment Margin Common Fixed Costs Operating Income 10,329.62 8,392.91 6,017.39 9,893.92 97,970.18 $74,767.51 $70,786.36 35,753.52 Taxes (35%) Net Income