To: Lawrence and David Sears

From: Akhil Arora, CPA

Re: Knead Bread Ltd. (KBL)

Optimal Product Mix

To determine the optimal product mix we should determine the contribution margin of each
product and evaluate the contribution margin (Selling Price – Variable costs) per minute for each
batch (CM/batch/minute). As I evaluated the CM/batch/minute, I would advise that KBL should
bake Rye Bread as per the current demand (2,400 loaves) which will utilize 800 minutes out 960
minutes. The remaining 160 minutes should be used to bake white buns. Unfortunately, to
maximize the profitability, KBL will not be able to meet its current demand of 900 dozens but
could only produce 480 dozen instead. The limitation of 16 hours (960 minutes) is due to the
restriction on oven utilization of 16 hours under health and safety legislation.

Buying a new oven will be beneficial as KBL can recover all the oven costs in less than a year,
approximately 11 months. The oven could be used to produce an additional 420 dozen buns
which will bring the additional cash flow approx.. $341K. However, before considering the
purchase of an oven, you should consider the quality of the oven as the number of parts has been
recalled and the replacement parts for the oven are unavailable locally. The unavailability could
affect the production and negatively impact the sales and some of the customers could take the
business to the competitor. Perhaps, you should consider purchasing a model similar to the
existing oven.

Based on the analysis in Appendix-I, I would recommend KBL to invest in a new oven, which
could help KBL in meeting the current demand and growing demands in the future.

Winnipeg Arena Deal

Winnipeg Arena requires KBL to supply 50 dozen white buns daily for the next 5 years for a
discounted rate of $2.99/dozen (current price is $3.09/dozen). KBL will have to purchase an
additional oven and Rex Machine to shape the buns. Based on the information available the
increased cash flow from the Winnipeg Arena deal and utilize the new oven to fulfill the current
demand of 900 dozens buns (currently, KBL can only fulfill 480 dozens), there would be a
positive cash flow for the next 5 years. Please see the tab “Appendix -II” for detailed
calculations.
As the analysis shown in Appendix-II indicates that purchasing new equipment will bring
additional cash and contribute to overall profitability. However, KBL should consider other
factors such as discounted prices, use of a particular brand of flour, and new machinery.
KBL sells white buns for $3.09 and the Winnipeg Arena is offering a discounted price of
$2.99.dozen. Other customers may found out about the pricing arrangements with Winnipeg
Arena and would negotiate the price to $2.99. However, with the new machinery, KBL can cut
the labor costs and reduce the variable cost to $34.25/per batch, compared to $38.75/per batch.
Lowering the variable cost will result in a contribution margin of $2.23/dozen, which is similar
to the contribution margin at the non-discounted price.

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 As Bouquet flour is a key sponsor of the Winnipeg Arena, KBL is required to use its flour for the
buns to be produced for the arena. The issue is that Bouquet flour is known for late deliveries and
quantity discrepancies. KBL should ensure that the quality of the flour is comparable to the
current supplier and could include key members of Winnipeg Arena to negotiate the delivery
terms and other issues addressed above with the key sponsor. Including Winnipeg Arena in
negotiations could lead the key sponsor to be more diligent.
If the deal is accepted KBL has to invest in an additional oven and a “Rex machine” to shape the
buns. The specialized equipment will be imported from Switzerland and would require annual
calibrations and if the machine requires any repairs, KBL has to bring one of the technicians
from Switzerland. KBL should conduct market research on the “Rex Machine” and inquire if any
competitors have experience using the same machine or machine from the same supplier. If the
machine breakdown and requires repairs, KBL could be subjected to a penalty from Winnipeg
Arena for not fulfilling the service level. KBL could also negotiate the timeline for the
machinery repairs as the “Rex machine” will be an important piece of equipment.
Based on the quantitative and qualitative analysis performed, I would recommend KBL to accept
the Winnipeg Arena’s deal and invest in new equipment.
Planning for retirement
Based on the information provided, I have reduced your monthly expenses to $4,960, currently
$6,200 (a decrease of 20%). As you have an RRSP worth $400K, you will have to convert the
RRSP to RIF as you can only withdraw money from RIF with minimal taxes. As you have stated
that the current average rate of return is 3%, the maximum amount you can earn is $3,286 which
is lower than expected expenses of $4,960.
I have completed an analysis, calculating the minimum rate of return, which will meet the
monthly spending indicated above. The minimum rate of return (ROR) required to earn $4,960 is
6.36%, which indicates that an aggressive strategy is needed to earn the minimum ROR indicated
above.
As you have mentioned that you would like to keep the house and would like to leave the house
to the family as an inheritance, you could consider downsizing and perhaps buy a house, which
will meet your needs.

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