Your team's role is to advise Cheong on the important decisions KML must make. Provide a report, documenting your team's analyses and recommendations, to Cheong to help him prepare for the management meeting. Your report should address the following:
- (i)The list of relevant and reasonable assumptions made (a portion of your grade will be attributed to the list of assumptions).The assumptions you make are an integral part of your case analysis.
- (ii)Your recommendations regarding thepertinent issues of interest to KML. Your recommendations should be clearly explained and, where appropriate,supported with relevant computations.
Bear in mind that your recommendations will have to be justifiable to the division management teams at KML.
Mini Case Study General Background Kang Motors Ltd (KML) is a local business specialising in the trading and servicing of cars. The company's office is located on the second level of a two-storey building along Ubi Road. The ground floor of the building is divided into three areas - the showroom for new cars, the used car mart and car parts shop, and the servicing and repairs centre. The company is a family-owned business. The current CEO is Mr Kang Cheong. During a restructuring exercise that started a year ago, Cheong structured KML into 3 divisions. Eachdivision is independently managed by a team. The 3 management teams are compensated solely based on contribution achieved by their respective divisions. New Cars Division (NCD) The source of NCD's revenue is the commission from sales of new car models. KML has been the sole local authorised distributor of new Fonda models for the last 20 years. The dealership terms with Fonda does not allow KML to raise the selling price of any new Fonda cars. For each new car sale, KML is paid a commission equal to a standard percentage of the prescribed selling price of the car. In addition, KML is required to provide servicing and repairs to Fonda cars that are under warranty (those within 3 years of purchase). Such servicing and repairs are provided free of charge to the Fonda new car owners, but KML is paid by Fonda at labour and imputed fixed costs plus an 80% mark-up. Car parts required for repair of Fonda cars under warranty are supplied, at no cost, by Fonda. This dealership agreement signed with Fonda almost 5 years ago is expiring in the near future. NCD is the process of negotiating a new 5-year dealership agreement with Fonda. The two parties are agreeable to maintain most of the terms of the existing agreement. However, Fonda is proposing to increase the new car sales commission paid to NCD by 10% on the condition that KML provides servicing and repairs to new Fonda cars under warranty at the cost of labour and imputed fixed cost (with no mark-up). NCD is of the opinion that Fonda, given their long-standing good working relationship with KML, is keen to enter into a new 5- year sole dealership agreement. However, NCD is also aware that a few other car agents have initiated dealership discussions with Fonda. Used Cars Division (UCD) The main source of revenue for UCD is from the trading of used cars. Currently, approximately half of the used cars traded by UCD are stocked from trade-ins from NCD's customers for new Fonda cars. The rest of UCD's used cars traded are from car sellers that "walk-in". The prices at which used cars are traded-in for new Fonda cars are negotiated by NCD. To value their used car inventory, KML uses a used car valuation guidebook published by UCD based on the division's knowledge of the market. Currently, NCD absorbs any trade- in loss that results from the difference between the price at which a used car is traded-in and the guidebook value. The valuation of a used car is complicated because even two used car of the same make, model and year of manufacture can have very different values due to mileage, maintenance or prior accidents. Unfortunately, this is further complicated in Singapore as fluctuations in the premiums of certificate of entitlement (COE) can directly affect value, and through demand, for used cars.' Used cars that cannot be sold in Singapore after months are either exported (usually at a much lower price than if sold on the local market) or taken apart and sold as used car parts by UCD. UCD's other source of revenue is from the sales of used car parts. UCD adopts the same mark-up on cost for all sales of its used car parts. Boss Motors, the only other car servicing You may find the article "Determining the estimated value of a pre-owned car" useful. http://www.oneshift.com/used-car-buying-guide/693/pre-owned-car-buying-guide-part-4-determining-the- estimated-value-of-a-pre-owned-carand repair centre in KML's vicinity, used to be UCD's major customer for used car parts. Recently, however, Boss Motors has completely ceased to order car parts from UCD. Servicing Cars Division (SCD) The source of revenue for SCD is from car servicing and repairs. Currently, SCD uses 25% of its capacity for Fonda cars under warranty, 30% for UCD and 40% for serving other customers. SCD charges services provided to UCD and other outside customers at full cost (including imputed fixed costs) plus an 80% mark-up. SCD imputes a fixed cost of $500,000 for its current capacity. Currently, new facilities that could increase SCD's capacity by 50% are being constructed and would be ready in 12 months. SCD's pricing is generally 10% lower than Boss Motors. Boss Motors has capacity that is similar to SCD but is only operating at about 50% of its capacity. All the used car parts required by SCD (other than those provided by Fonda for cars under warranty) are supplied by UCD. Very recently, SCD was approached by another local car dealer - Akura. Akura is looking to outsource the servicing and repairs of Akura cars under warranty. If the deal is successful, serving Akura customers will require 30% of SCD's current capacity. Akura has offered to pay SCD at full costs plus 50% mark-up. Akura has indicated that they want to start the deal as soon as possible. Management Meeting The restructuring that started a year ago is not fully completed. Cheong has not decided on explicit corporate policies on (i) whether the divisions have complete freedom in their sourcing decisions; and (ii) whether the divisions can choose to turn away internal business. Cheong has been presented with the divisional contribution figures below for the past year. These numbers have implications for paying bonuses to the three management teams, determining future corporate policies, and planning for future resource allocations and requirements. Cheong has called for a meeting, with all the divisions, to address issues pertinent to KML. NCD Commission from New Car Sales $2,800,000 Trade-in Loss ($350,000) Less: Variable Costs $950,000 Equal Contribution $1,500,000 UCD Sales of Traded-in Cars $6,400,000 Sales of Walked-in Cars $6,450,000 Sales of Car Parts $700,000 Less: Costs of Traded-in Cars $4,950,000Costs of Walked-in Cars $5,400,000 Costs of Car Parts Sold $437 500 Servicing & Repair Costs $780,000 Other Variable Costs $450 000 Equal: Contribution $1 532 500 SCD Servicing and Repairs Revenue $2,760,000 Less: Parts Costs $350,000 Labour Costs $900,000 E1131: Contribution $1,510,000
