BALDWIN BICYCLE COMPANY: Analysis

1stly, we look at the Income statement. COGS for year ended 1988 is Rs
80,45,000. This value consists of 3 components: Raw Materials & Direct Labour
(Variable) + Mfg Overhead. Now, from exhibit 2, overhead cost/unit is 24.50. as
40% of total production overhead is variable, Fixed cost/unit will be (24.5*0.6)=Rs
14.7, and based on volume of 1,00,000 annual units, total Fixed Costs will be Rs
(14.7*1,00,000) = 14,70,000

Now, according to the case, Baldwin is currently operating at 75% capacity and
producing 98,791 units.

If Baldwin operates at 100% capacity, it can produce maximum (98,791/0.75) =

1,31,721 units annually. Accepting additional 25,000 orders will result in annual
production of (98,791+25,000) =1,23,791 units, which is within the maximum
production capacity of 1,31,721 units. So there will be no incremental increase in
Fixed costs and will remain Rs 14,70,000

Now, we calculate the Break-even units (BEP) & Margin of Safety (MoS) for
existing products.

Calculating the Contribution/unit cost for Standard model:

COGS 80.45 (80,45,000/1,00,000)
fixed cost 14.7 calculated above
variable cost 66.5 (80.45-14.7)/0.98791

Standard Challenger
(1,08,72,000/98,791)
Revenue 92.29
110
Variable Cost
RM 37.1 39.8
DL 19.6 19.6
66.5
(24.5*0.4)
Mfg overhead 9.8
9.8
Contribution/unit 43.5 23.09
Break–even units = Total Fixed cost/(Contribution/unit) =
(14,70,000+23,54,000)/43.5 = 87,908

MoS = (actual annual sales-BeP)/actual annual sales = (98,791-87,908)/98,791 =

11.02%

Hence, it is crucial for Baldwin to accept the offer as it will add to volume sales as
current MoS is very thin.

Also, from Balance Sheet, we can figure out that 1988 Debt/Equity ratio is
4,990/3,102 = 1.6 which is quite low.

2ndly, there is huge inventory (25% annual revenue), hence taking the order will
liquidate the inventory and reduce inventory holding cost drastically.

Baldwin is also not in good financial health in terms of Working Capital.

But, further investment requires capital infusion for scaling up operations.

We now find out the Relevant Revenues, Relevant Costs & Relevant Investment.

Relevant Investment
one time cost 5,000 Working
Raw Materials (2 months'
1,65,833.33 (25000/6)*39.8
supply)
Work in Progress
100% RM 39.8
50% DL 9.8 (19.6*0.5)
50% variable mfg
overhead 4.9 (9.8*0.5)
Total units (from exh 4) 1,000
WIP Total 54500 (39.8+9.8+4.9)*1,000
Finished Goods
Own warehouse 34600 (500*69.2)
with client 2,88,333.33 (25,000/6*69.2)
Total FG 3,22,933.33
Accounts Receivables 1,92,270.83 (25,000/12)*92.29
Total amount 5,74,704.17
 Relevant Cost
RM 39.8
DL 19.6
Mfg overhead 9.8
contribution/unit 69.2
Units 25,000
Product cost 17,30,000 (69.2*25,000)
Amortization 1,666.67 (5,000/3)
A/c Receivables (pt 4)
(11.5+2)% 25,956.56 (192,270.83*.135
Inventory (23%) (RM+WIP+FG) 1,24,951.3 (165833.33+54500+322933.33)*.23
Cannibalization 1,30,500 (3000 cycles*43.5)
Total Amount 20,13,075

Relevant Revenue = (25,000 units)* Contribution/unit = (25,000*92.29)

=23,07,250 which is more than the cost of 20,13,075.

Hence, Baldwin should definitely accept the proposal.