You had not heard from Elena Lombardo since she transferred from Maryville University to attend school in Denver, Colorado. You could sense her excitement when she called you to share her news.

She had an opportunity to acquire a business in a field she knew well: rock-climbing.

It seemed Elena was fated to go into a business related to the outdoors. She was born in Bolzano, Italy, just one and a half hours from the Dolomites. There she went on long hikes and climbing expeditions with her father, who shared his love of the outdoors, and rock-climbing with her.

You and Elena became friends as freshmen when you attended Maryville University. While Elena majored in marketing, you majored in accounting. You shared an interest in the outdoors, taking long hikes on the trails outside of St Louis and free climbing the cliffs along the Missouri River.

After three years, Elena decided to return to Colorado and complete her studies in Maryvilles On-Line program. During her first summer back in Denver, she secured an internship position at an established company that specialized in retail mountaineering equipment. She worked in the department that organized and operated rock-climbing tours. While there she developed the idea that led to her current business opportunity. A critical tool for rock climbers is the piton, a device like a flat spike that the climber hammers into crevices in the rock wall in order to attach support lines. These tools need to be strong enough to be driven into the rocks and removed numerous times. That strength comes at the expense of added weight, which is a significant issue for climbers, since they typically carry many pitons.

She shopped her employers store looking for lightweight pitons, but could only find ones made of steel. She asked the owner why none of the pitons were made of titanium, or some other lightweight alloy. He replied that they tried a titanium product from Russia, but it was very expensive and of low quality. He told her if she could reliably obtain titanium pitons at the right price and quality, he would be willing to buy them.

Elena began to research the potential to produce high quality pitons from titanium. It turned out to be less complicated than she anticipated, and, after several tries, she designed one that would take advantage of titaniums superior strength, while weighing significantly less than the standard steel product. Then she identified a company in the Denver area that did drop forging, the key to the production process. She made inquiries and learned the company had excess capacity and could produce the product in volumes she believed she could sell. Within weeks, Bolzano Titanium (consisting entirely of Elena) was in business, purchasing titanium bars and having them delivered to the forge, where they were converted into the finished product and delivered to the retail store in Denver.

Elenas trial order was for 1,000 units, but soon she had a reorder rate of 1,000 units per month. The retailer paid her $30.00 per piton. The raw material cost of the titanium came out to $10.00 per piton, and the forge charged her $20,000 to make and pack an order of 1,000 pitons. Clearly, she was not making any money. In fact, a minimum wage job would have paid her more. However, what mattered to her was the proof of her concept - she could successfully design and sell her product. For a marketing major, this was a tremendous confidence builder! The start-up risk had been low, and she now had her own business.

Three phone calls changed the landscape. First, she received a call from the owner of the Denver retailer. He told Elena he was impressed with her product and made the following offer: If you give me an exclusive supplier arrangement for two years, I will guarantee you a purchase volume of 4,000 units per month at $25.00 per piton for the length of the contract. Actually, I think it could be 10% higher, but Im only willing to guarantee 4,000. Her elation at the offer quickly evaporated because the $25.00 price would not cover her current costs. She wasnt sure if the forge would grant her a cost break because of the extra volume, or, more importantly, if the forge had the available capacity to quadruple production.

The second phone call was from the owner of the forge. He had decided to close the forge and retire to Arizona. He asked if she was interested in taking over the forge. She felt her jaw drop, but quickly recovered and said she might be interested, but would need some operating data first.

She learned that the forge had thrived making titanium implants for joint replacements, but that business had shifted to China. In fact, the owner of the forge admitted that for the last few months Elena had been his only customer. He operated a forge with a minimum crew of ten, each able to operate all the equipment in the forge. Her current volume of 1,000 units required only one week of labor. She asked if the workers could produce more than 1,000 units per week, and the owner speculated about 1,100 units. She realized she would need all ten workers if her demand increased to 4,000 units per month. The forge was in operation twelve months a year but shut down periodically for vacations and forge maintenance. Elena could count on forty-eight weeks of production capacity annually.

The workers were paid wages of $60,000 each, including benefits like holiday and vacations. Operating costs (fuel, property taxes, insurance, maintenance, and utilities) totaled $100,000 last year. Elena estimated administration costs to be around $1,000 a month, or $12,000 per year. Finally, the forge owner offered to sell the forge for $40,000, IF Elena agreed to retain all ten of the forge workers at their current salary. Elena would depreciate the forge over 10 years using Straight Line depreciation.

The third phone call was to her father. She explained the offer to him; She would quit school to devote 100% of her time to running the business. While he had misgivings, he agreed to loan Elena the purchase price, at 1% annual interest, with the principal due in five years. He wanted to encourage Elenas entrepreneurial ambitions.

Elena realized this could be a once in a lifetime opportunity. She had guaranteed demand. She would forego a salary for at least the first year.

Registration for the Fall term is fast approaching. She must decide!

She decided to call you for an objective opinion. You understand her love for the outdoors, and she remembered that you received an A in ACCT 211. She is confident you can advise her in this matter.

1. Based on the retailers offer, calculate Elenas revenue, contribution margin and operating income under the status quo, the retailers baseline offer, and the potential 10% increase. Present the data in a Contribution format Income Statement for Elenas first year of operation. (Ignore income taxes.) (40 pts)

(I suggest you start with unit data; then calculate the annual data.)

1. Which costs are variable, and which costs are fixed? (10 pts)
2. What is the relevant range for the forge? (10 pts)
3. Is Direct Labor variable or fixed, and why? (10 pts)
4. Calculate her breakeven units. (10 pts)
5. Calculate her Margin of Safety in units (for both baseline and 10% increase). (10 pts)
6. Is the Degree of Operating Leverage high or low? (Explain your answer.) (10 pts)
7. What is your advice to Elena? Should she stay in school and complete her degree, or should she throw caution to the wind and go into the rock-climbing equipment business? BE SURE TO SUPPORT YOUR RECOMMENDATION WITH DATA! (The status quo is NOT an option! The owner is closing the forge if he does not receive an offer from Elena.)