ACCT 551 FINAL CASE STUDY SPRING 2016 The purpose of this case study is to help you integrate the managerial accounting concepts that were covered in class and apply them to a real-world business setting. Business Description You will assume the role of an entrepreneur to start a small company. Your company will rent a retail cart inside the Mall of America to imprint T-shirts with exclusive original designs by a famous artist who is a friend of yours. Your friend has agreed to design these T-shirt pictures for you each year at a special discount. Your target customers are teenagers and young adults who have your kind of good taste. Your business is scheduled to launch on January 1, 2017. Cost information: 1 Mall of America charges you $2,500 rent per month, which includes utilities, cleaning, and maintenance. 2 You will order white, cotton T-shirts from a T-shirt wholesaler. Each T-shirt costs $3.00 to purchase (cost includes taxes, shipping, and handling). 3 To store T-shirts that were bought, but not yet imprinted, you will rent a storage unit. The storage unit costs $75 per month. 4 You agreed to pay your artist friend a $3,000 annual contract fee for twelve T-shirt designs. This same term is renewable for the next 3 years. Each T-shirt picture will only be used for one year. Therefore, in the second year, 12 new pictures will be designed for another $3,000 annual contract fee. 5 You will buy several items before the start of your business: a. Computer and printer – cost $5,000. They are expected to last 3 years without salvage value. Straight-line method of depreciation should be used. b. Heat press machine – cost $2,500. The machine is used for imprinting T-shirts only and is expected to last 3 years without salvage value. c. Transfer paper – Each case of transfer paper costs $400 and contains 1,000 sheets of 8.5 x 11 transfer paper. One transfer paper is used to print one T-shirt. d. Ink-jet cartridges – On average, each cartridge costs $50 and can make 500 prints. Each T-shirt requires one print. 6 Each T-shirt costs about $0.20 to wrap and box. 7 Students are hired as part-time workers. On average it takes one labor hour to print 10 shirts. Folding and packaging 20 shirts takes about one labor hour. Each worker is paid $10 per hour. 8 A liability insurance policy is purchased at a cost of $3,600 per year to protect the business from legal obligations. Questions: 1 Name your company (5 points) 2 What and how much are the variable costs? Present each item in cost per T-shirt basis (5 points). 3 What and how much are the fixed costs? Present each item in total cost per year (5 points). 4 Write out the annual cost formula in Y = a + bX format (5 points). 5 Assume that you make and sell 12,000 T-shirts in the first year. Use the cost formula to calculate the first year’s total cost. If the T-shirts sell at $15 each, how much would net profit be in the first year? (10 points) 6 Based on the estimated sales level of 12,000 T-shirts for the first year, prepare the company’s forecasted income statement for the year ended on 12/31/2017 (10 points). 7 Calculate contribution margin per T-shirt and contribution margin ratio (5 points). 8 Calculate how many T-shirts need to be sold in order to break-even. Calculate how much sales in dollars are needed to make in order to break-even (10 points). 9 Prepare a cost/volume/profit chart (10 points). 10 Calculate how many T-shirts need to be sold in order to make a $25,000 target profit for the year (5 points). 11 Based on the assumption that 12,000 T-shirts will be made and sold during the first year of business, calculate the margin of safety and the operating leverage for the business. What do these figures tell you about how risky the business is? (10 points) 12 If sales could increase by 1,200 shirts (i.e. a 10% increase), by how much in dollars would net operating income increase? By what percentage would net operating income increase? (5 points) 13 Prepare a contribution format income statement assuming a sales increase by 10% to 13,200 shirts. Compare your new net operating income with your answer in 6 (10 points). 14 Calculate the total amount of cash that will be needed prior to the launching day of the business in order to buy all necessary equipment and machines, purchase all materials and supplies needed for the first three months of operations, and to pay the employees’ first three months wages. This amount will be your initial investment in the business. Following is information regarding the cash needs for variable and fixed costs: a. Variable costs and expenses i. For every variable cost item, sufficient quantity will be purchased to make the first 1,000 T-shirts. Sufficient cash will also be required to pay the labor costs for making, folding, and wrapping the first 1,000 T-shirts. b. Fixed costs and expenses i. The initial amount of cash should be sufficient to pay for the first quarter’s cash needs for fixed costs. 1. Rent, storage unit costs, and liability insurance will be paid monthly 2. The payment to the artist, computer and printer, and heat press machine will be paid on January 1, 2017. (10 points) 15 16. 17. 18. Prepare a cash budget for the company’s first year of operations. Assume that the selling price is $15 per shirt and that 12,000 T-shirts will be made and sold in the first year. Assume all sales are cash sales and that all costs and expenses are paid in cash. The initial cash balance is the amount calculated in #14. You decide to maintain a minimum cash balance of $10,000 at December 31, 2017 (15 points). Calculate the first year’s estimated return on equity (note that beginning equity will equal the initial investment in the business calculated in #14). (5 points). After reviewing the budgeted income statement and the estimated return on equity for the first year of operations, you are disappointed at the estimated net income and the low rate of return. Consider business strategies that will help to improve profitability. a. Develop a business strategy which will involve at least three changes. Changes may be made in variable cost per t-shirt, total fixed costs, and/or selling price per T-shirt. For example, you could propose to use better quality T-shirts, sell the T-shirts at a higher or lower price, increase the advertising budget, draw the T-shirt pictures yourself, move business location to a less expensive location, or some other strategy. Describe your strategy clearly and justify why you believe the strategy will work. b. Provide the variable cost per T-shirt, total fixed cost, selling price per Tshirt, and contribution margin per T-shirt under your new strategy. Provide the new cost formula. What is the new break even? c. Under your revised strategy, how many T-shirts may be sold under the best case scenario and the worst case scenario? Calculate the net income under the best case scenario and the worst case scenario (15 points). After your thorough analyses of costs, sales, and profitability of your T-shirt business throughout the project, what is your overall impression of the future potential of the business? Provide a short assessment (10 points).