ROWE POTTERY WORKS, INC.

At the end of 2003, Rowe Pottery Works, Inc. (RPW) had been losing money for over two and a half years. This case challenges students to identify and evaluate alternatives that lead to Rowe's return

to profitability. RPW's pottery operation is the main source of the losses. The pottery operation provides

a majority of the company's revenue leading the company to depend heavily upon its success. Attempts to

control costs have reduced but not eliminated the continued losses. The losses perplex the company's

president as he believes there is a strong market for RPW's products.

Management recently hired a new controller but is skeptical whether or not an accountant can help turn the

company around. The previous controller told the president on numerous occasions: "I just report the results."

Nonetheless, the president hopes the new controller can help find a way to return the company

to profitability.

COMPANY HISTORY

Jim and Tina Rowe purchased a historic blacksmith shop in 1975. They turned it into an antique shop and

soon discovered there was quite a demand for 19th-century salt-glazed pottery. Jim studied art in college

and was familiar with the salt-glazed technique. He and Tina began producing handmade salt-glazed pottery

and selling it in their store. As demand grew, the Rowes began selling their pottery to gift shops across

the country. Today RPW sells more salt-glazed pottery than any other producer in the country.

RPW also operates a retail store and a wholesale decorative ironworks business. The focus of this case

is on RPWs salt-glazed pottery business. Information about the store and iron works has been removed

from the financial data presented.

THE ACCOUNTING SYSTEM

RPW relies on a fairly sophisticated accounting system. RPW assigns each product a standard cost based

upon estimated material, labor and overhead costs. Material costs account for about 10% of the total standard

cost. The remaining 90% represents labor and overhead.

The kiln represents a significant fixed cost to the company. Management also considers a significant

portion of its labor costs (80%) to be fixed. Potters and decorators take a long time to train and management

is very careful not to lay off these important employees more than once a year. By limiting the

number of layoffs management reduces the risk that these skilled employees will leave the company. As a

result, labor costs act more like fixed costs.

The pottery contains relatively few variable costs. Variable costs include the costs of all materials

(i.e. , clay and glaze) and approximately 20% of overhead costs. The remainder of overhead costs do not

vary with production levels.

RPW values pottery inventory at standard cost. It tracks variances and charges them to cost of goods

sold throughout the year. Table 1 lists the costs of goods sold for each of the last five semi-annual periods

broken down into standard costs and total variances. The company has been actively cutting costs.

Evidence of this reduction can be seen in the reduced variances and production costs over the five periods.

A NEW KILN

RPW is considering purchasing a new kiln. It currently operates two kilns, each of which can process

$10,000 worth of pottery per firing. The company received a quote of $500,000 for the materials to build

a new kiln and the space to house it. Costs to erect the kiln, build the necessary additional space, and prepare

it for production are projected at an additional $250,000. A new kiln will take one year to prepare for

production.

RPW will have to finance the kiln with debt. The companys current interest rate is 10% (2% over

prime). RPWs bank is reluctant to make such a large loan given RPWs current financial position.

However, the bank believes it may be able to put together a group of area banks to finance the kiln with a

13% fixed rate loan requiring annual payments over five years. RPW estimates its required rate of return

at 15% for this project.

The expected life of a kiln is seven years after which a major overhaul will be necessary. The kiln and

additional space will be essentially worthless without the major overhaul. Assuming the kiln is fired twice

a week, 50 weeks a year, with an average firing producing $10,000 worth of product (in sales dollars), the

kiln would increase sales capacity $1,000,000. The company expects it could sell half of this increase in

the first year with additional increases of $100,000 per year afterward. RPW estimates the cost to produce

goods with a new kiln excluding depreciation at 45% of sales. Current marketing related costs average

20% of sales. RPW expects marketing expense to remain 20% on the additional sales because variable selling

expenses will increase, but fixed marketing expense will be spread over more sales. Administrative and

general expenses should be unaffected by adding a new kiln.

1) Evaluate the purchase of a new kiln using the NPV method. Use the correct format.

2) Should the company purchase a new kiln? Consider Qualitative Factors and provide a brief explanation.

ROWE POTTERY DIRECTIONS 1. Prepare a worksheet as follows: Beg yearEnd year 1 year 2 year 3 year 4 year 5y year 6year 7 2. Beg year 1 (now) is the purchase price 3. Nothing is happening in year 1 since the project will take 1 year to complete. So, the "end year 1" column will be blank. 4. Sales will be $500,000 for end of year 2 and will increase by $100,000/year after that 5. cost to good sold are 45% of sales for each year 6. Selling expenses are 20% of sales for each year 7. Use discount rate of 15% to calculate present values from the table 8. All other amounts in the case are for information purposes only and will not be used irn the calculations