Simran Tea Sanctuary (STS) is a local caf chain in Vancouver, British Columbia,

founded by Victor and Lucie Stone. STSs reputation was built around the caf

business; however, STS also owns a small manufacturing plant that produces

sustainably-sourced bottled teas. The couple wanted to provide the community with

organic teas while acting responsibly toward the environment. The Stones have just

retired, passing the business on to their daughter, Aurora, who shares a similar

commitment to the environment and her community.

It is May 2020 and you, CPA, work as an independent consultant. You have been

approached by Aurora, who would like your advice on some of her recent initiatives and

ideas.

In 2018, STS started to capitalize on the growing demand for Kombuchaa fermented

tea drink thats supposed to offer several health benefitsby producing and selling its

own fresh, bottled Kombucha.

This year, Aurora started offering Kombucha-making classes to STSs customers.

Based on the response from customers, Aurora thinks the Kombucha classes have

been a massive success but she would like to know what class size she needs to break

even, and to earn a target pre-tax profit of $200 per class. Aurora also wants to know

what price she needs to charge in order to earn her target profit and would appreciate a

discussion of any qualitative impacts of setting a target profit (Appendix I).

Aurora has noticed that the popularity of bottled Kombucha and Yerba Mate, an herbal

tea, have increased dramatically over the past two years. Because of its fermentation

process, Kombucha takes longer to produce and requires more space than STSs other

bottled teas. Aurora has been approached by a local company, Tea4U, who offered to

produce the bottled Kombucha for STS for $7.80 per bottle. Tea4U produces and

supplies high-quality bottled teas to STSs cafs and to other small distributors, and can

produce more bottles than STS currently produces. Although the company has only

been in operation for two years, Tea4U is growing rapidly and is known for its quality

products. If STS outsources the Kombucha production to Tea4U, it will have to share its

proprietary recipe with Tea4U. Aurora wonders if she should outsource bottled Kombucha to Tea4U and use the resulting production capacity to start producing Yerba

Mate tea instead (Appendix II).

Aurora has recently been approached about partnering with Organic Essentials Inc.

(OEI), a large company based in Vancouver that sells essential oils. She would like you

to analyze this opportunity and tell her if this is a good fit for STS (Appendix III).

Finally, as Aurora sees more opportunity in selling the bottled tea than in selling fresh

tea in the cafs, she is considering replacing STSs existing manufacturing plant with a

larger facility. She would like you to analyze this expansion opportunity, which would

double the bottled tea capacity, using the discounted cash flow model (Appendix IV).

APPENDIX I

KOMBUCHA-MAKING CLASSES

STS offers Kombucha-making classes at its manufacturing plant on weekend mornings.

Each class holds 20 students, who pay $25 each, and the classes are always full.

Aurora pays a local Kombucha maker $250 to teach each class. Students are provided

with ingredients to make a sample of Kombucha (cost of $3 per student) and a small

recipe book to take home (cost of $4 per student).

Each student may also purchase one take home starter kit at a discounted price of $35,

which is $5 above cost. These kits are normally sold in the cafs for $60. Aurora

estimates that about 50% of students buy the kit. She wonders how the sales of starter

kits is impacting her pricing strategy

APPENDIX II

KOMBUCHA OUTSOURCING AND YERBA MATE PRODUCTION

Financial details of current Kombucha production

Per bottle

Selling price $8.50

Direct materials (ingredients) $1.50

Production workers (0.07 hours per bottle $14 per

hour)

$0.98

Packaging (labels and bottles)1 $1.50

Shipping costs1 $0.50

Current demand2 2,500 bottles per

month

1 Tea4Us price includes the packaging costs but not the shipping costs.

2 Tea4U has sufficient capacity to deliver 2,500 bottles per month.

If STS decides to outsource Kombucha production to Tea4U, it can use the vacant

space to produce an additional 3,000 bottles of Yerba Mate per month.

Financial details of Yerba Mate production

Per bottle

Selling price $6.00

Direct materials (ingredients) $0.50

Production workers (0.02 hours per bottle $14 per

hour) $0.28

Packaging (labels and bottles) $1.50

Shipping costs $0.50

Fixed costs related to the manufacturing plant are as follows:

Per month

Production managers salary $ 5,500

Marketing costs for all bottled tea products $ 1,000

Other fixed costs (facility lease, equipment depreciation,

etc.) $15,000

APPENDIX III

ORGANIC ESSENTIALS INC. (OEI)

One of Auroras friends recently started working for OEI. OEI commercialized the sale of

essential oils by successfully finding the cheapest and most efficient way to harvest and

extract essential oils from plants and flowers located all over the world.

Auroras friend told her that market studies have shown that those who enjoy organic

tea are more likely to also have an interest in essential oils; therefore, she thinks STS

and OEI would make a perfect partnership. Aurora has never tried OEIs products but,

given the companys rapid growth, notes that they seem popular.

As all OEI products are sold on consignment, there would be no cost to STS. OEI would

send sales agents to STSs cafs to distribute free samples to customers and talk to

them about the benefits of the products. Aurora thinks this might be one way to diversify

STSs product offerings, which currently consist of tea and Kombucha.

OEI was recently reported in the media as having caused extensive environmental

damage in the countries where their essential oils are extracted. In the past, there have

also been rumours that OEIs manufacturing facilities abroad are not well maintained,

and its employees are treated poorly.

APPENDIX IV

FACILITY EXPANSION AND ADDITIONAL EQUIPMENT

If Aurora decides to expand, production at the new facility would start in 2021. STS

requires a 12% return for all of its investment projects.

Leasing costs Year 1

1 $240,000

Fixed costs Year 1

2 $ 75,000

Initial setup costs unrelated to new equipment $ 40,000

Additional contribution margin per bottle $ 3.80

Cost of new equipment required $ 58,500

Useful life, new equipment 7 years

Salvage value at the end of useful life $ 15,000

Notes STS expects to produce and sell an additional 66,000 bottles of tea in the first

year. This additional volume will increase by 15% each year from Years 2 to 5 and will

remain the same as Year 5 for the remaining two years.

Ignore tax in your analysis.

1 STS would sign a contract for a 7-year lease, with lease payments increasing by 2%

annually.

2STS expects a 1% increase per year in fixed costs for the next seven years. Fixed costs

include the depreciation cost of the new equipment.