Business Description:
Your project group will assume the role of young entrepreneursto start a small company. Your company will rent a retail cartinside the Stonebridge Mall to buy plain T-shirts and imprint themwith one of the twelve beautiful pictures exclusively designed foryour company by a famous artist who is a friend of yours. He hasagreed to design twelve super attractive T-shirt pictures for youeach year at a special discount. Your target customers areteenagers and young adults who have your kind of good taste. Yourbusiness is scheduled to launch on January 1, 2014.
Cost information:
1) Stonebridge charges you $2,500 rent per month, which includesutilities, telephone, cleaning, and maintenance. You estimated that90% of the rent was related to factory operations and 10% wasrelated to selling and administrative activities.
2) You will order white, cotton t-shirts from a T-shirtwholesaler. Each T-shirt will cost (including taxes, shipping, andhandling) $3.75 to purchase.
3) To store T-shirts that were bought, but not yet imprinted,you will rent a storage unit. The storage unit costs you $125 permonth.
4) You agreed to pay your artist friend a $10,000 annualcontract fee plus a $300 design fee for each of the 12 T-shirtpictures designed. This same term is renewable for the next 3years. Each T-shirt picture will only be used for one year.Therefore, in the second year, 12 new pictures will be designed at$300 each and another $10,000 annual contract fee will becharged.
5) You will buy several items before that start of yourbusiness:
a) A computer and a printer: You will pay $6,000 (includingtaxes, shipping and handling) to buy a computer and a printer. Youexpect both to last about 3 years without salvage value. You willuse the straight-line method for depreciation. You estimate thatabout 90% of the computer and printer will be used for factoryoperations and 10% will be for selling and administrativeactivities.
b) A heat press machine: You will pay $4,500 (including taxes,shipping and handling) for a heat press machine. The machine isused for imprinting t-shirts only and is expected to last 3 yearswithout salvage value.
c) Transfer paper: Each case of transfer paper costs $400 andcontains 1,000 sheets of 8.5Ã11 transfer paper. You expect to useone transfer paper to print one T-shirt.
d) Ink-jet cartridges: On average, each cartridge costs $50 andcan make 500 prints. Each T-shirt requires one print. You also needto print flyers, etc. for selling and administrative purposes. Forthis non-manufacturing printing, you will print about one page forevery 5 T-shirts sold.
e) Laser paper: You will buy several reams of laser paper toprint promotion flyers, etc. Each ream costs $20 and contains 200sheets of 8.5Ã11 laser paper.
6) Wrapping paper and box: Each T-shirt costs about $0.20 towrap and box. Wrapping and boxing are not considered asmanufacturing.
7) You will hire three fellow students as part-time workers.They not only help you operate the machine, but also help fold,wrap and box T-shirts. Sometimes, three of them work at the sametime. But, sometimes they donât because of their different classschedules. On average, printing 10 shirts will take one labor hour.Folding and packaging 20 shirts also will take about one laborhour. You will pay each of your workers $8 per hour. Folding andwrapping are not considered as manufacturing.
8) You (the owners) do all the selling and administrative workby yourselves. You will pay yourselves a total of $12,000 per year(to be divided among all owners).
9) To protect your business from legal obligation, you willpurchase a liability insurance that will cost you $3,600 peryear.
10) You will hold four end-of-quarter parties to promote salesof your t-shirts. Each party costs you about $1,000.
Section Two Requirements:
Now you have developed your cost estimates, letâs do someevaluations on this proposed business.
1. Continue to assume that 7,800 t-shirts will be made and soldin the first year. What is your product cost per unit underabsorption costing? What is your product cost per unit undervariable costing?
2. Based on the estimated sales level of 7,800 t-shirts for thefirst year, prepare your companyâs (forecasted) income statementfor the year ended on 12/31/2014 using both (a) the traditionalformat based on the absorption costing and (b) the contributionformat based on the variable costing.
3. Calculate contribution margin per T-shirt and contributionmargin ratio.
4. Calculate how many T-shirts you need to sell in order tobreak-even. Calculate how much sales in dollars you need to make inorder to break-even. (Use break-even formulas.)
5. Calculate how many T-shirts you need to sell in order to make$10,000 target profit for the year.
6. Continue to assume that 7,800 T-shirts will be made and soldduring the first year. Calculate your (a) margin of safety and (b)degree of operating leverage (DOL) for your business. What do thesefigures tell you about how risky your business is?
7. If sales could increase by 1,560 shirts (i.e. a 20%increase), by how much in dollars would net operating incomeincrease? By what percentage would net operating income increase?(Use the âquickâ way, i.e. contribution margin concept and DOL, youhave learned in class to answer these questions. Do not recalculatenet operating income.)
8. Prepare a contribution format income statement assuming asales increase by 20% to 9,360 shirts. Compare your new netoperating income with your answer in Question â2â and provemathematically that your answers to the two questions in Questionâ7â are correct.
9. Ignore Questions â7â and â8â. If the cost per plain t-shirtis expected to increase by 20% and sales (in number of T-shirts)are expected to be 5% less, how much is your projected netoperating income (or loss)?
10. Continue Question â9â. If the only expense you can cut isthe salary paid to yourselves, how much salary should you cut inorder to break even?
11. Ignore Question â9â and â10â. Assume that you have produced7,800 t-shirts, but the actual sales for the first year turn out tobe 7,000 T-shirts instead of 7,800. I.e. you will have 800 T-shirtsleft at the end of the first year. Prepare (a) a traditional formatincome statement and (b) a contribution format income statement.Are the two net operating income figures the same? Why or whynot?
12. Continue â11â. At what amount would inventory be reported inthe balance sheet of 12/31/2014 under (a) the absorption costingand (b) variable costing? Are the two ending inventory figures thesame or different? Why?
