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“In my opinion, it will be a mistake if the new plant is built,” said Steven Webber, controller of Tanka Toys. “Why, if that plant was in existence right now, we would be reporting a loss of $100,000 for the year 2014 rather than a profit, and 2014 sales have been the best in the history of the company.
Mr. Webber was speaking of a new, automated production facility that Tanka Toys is considering building. The company was organized only seven years ago, but it is growing rapidly due to its innovative new toys. Annual sales since inception of the company, along with net income as a percentage of sales, are presented below:
Year Sales Income as a percent of sales 2008 $  800,000 7.4 2009 1,900,000 7.0 2010 2,600,000 6.1 2011 3,000,000 5.3 2012 2,400,000 1.2 2013 3,700,000 3.8 2014 4,000,000 3.0
Year Sales Income as a percent of sales 2008 $  800,000 7.4 2009 1,900,000 7.0 2010 2,600,000 6.1 2011 3,000,000 5.3 2012 2,400,000 1.2 2013 3,700,000 3.8 2014 4,000,000 3.0
Year Sales Income as a percent of sales
Year
Year
Sales
Sales
Income as a percent of sales
Income as a percent of sales
2008 $  800,000 7.4
2008
2008
$  800,000
$  800,000
7.4
7.4
2009 1,900,000 7.0
2009
2009
1,900,000
1,900,000
7.0
7.0
2010 2,600,000 6.1
2010
2010
2,600,000
2,600,000
6.1
6.1
2011 3,000,000 5.3
2011
2011
3,000,000
3,000,000
5.3
5.3
2012 2,400,000 1.2
2012
2012
2,400,000
2,400,000
1.2
1.2
2013 3,700,000 3.8
2013
2013
3,700,000
3,700,000
3.8
3.8
2014 4,000,000 3.0
2014
2014
4,000,000
4,000,000
3.0
3.0

Although the company has always been profitable, in recent years rising costs have cut into its profit margins. The main production plant was constructed in 2007, but growth has been greater than anyone anticipated, making it necessary to rent additional production and storage space in various locations around the country. This spreading out of production facilities has caused costs to rise, particularly since the company is somewhat limited in the amount of automated equipment that it can use and therefore must rely on training a large number of new workers each year during peak production seasons.
Tanka Toys produces about 75 percent of its toys between April and September and only about 25 percent during the remainder of the year. This seasonal production pattern is followed by many toy manufacturers, since it saves on storage costs and reduces the chances of toy obsolescence due to style changes. Other toy manufacturers produce evenly during the year, thereby maintaining a stable work force. Carrie Russell, manufacturing vice-president of Tanka Toys, is pushing the new plant very hard, since it would permit Tanka toys to produce on a more even basis, as well as to automate many hand operations and thereby dramatically reduce variable costs.
Tanka’s management recognizes that much of the company’s success is due to the creative efforts of Kayla Dernier, head of the company’s new products department. Kayla has developed new toys that have revolutionized some areas of the toy market. Her talents are now becoming recognized by competitors, and Tanka’s management is concerned that one of the competitors may be successful in “buying” her away from the company.
Although total toy sales are quite stable, individual toy manufacturers can experience wide fluctuations from year to year according to how well their toys are received by the market. For example, Tanka Toys “missed the market” on one of its toy lines in 2012, causing a 20 percent drop in sales and a sharp drop in profits, as shown above. Other manufacturers have experienced even sharper drops in sales, some on a prolonged basis, and Tanka Toys feels fortunate in the sales stability that it has enjoyed.
Mr. Webber points out that although variable costs will be reduced by the new plant, fixed costs will rise steeply, to $1,700,000 per year. On the other hand, fixed costs are now $450,000 per year. Mr. Webber is confident (and Ms. Russell agrees) that with stringent cost controls variable expenses can be held to 82 percent of sales if the company continues with it present production setup. Variable expenses will be 60 percent of sales if the new plant is built.
Ms. Russell points out that marketing projections predict only a 10 percent annual growth rate in sales if the company continues with its present production setup, whereas sales growth is expected to be as much as 15 percent annually if the new plant is built. The new plant would provide ample capacity to meet projected sales needs for many years into the future. Economies of expansion dictate, however, that any expansion undertaken be made in one step, since expansion by stages is too costly to be a feasible alternative.
REQUIRED:
Assuming that the company continues with its present production setup: Compute the break-even point in sales dollars (2.5 pts.) Prepare a contribution format Income Statement  for each of the next three years (2015 – 2017) using projected sales as follows (these figures assume a 10 percent growth rate in sales each year):  (5 pts.)
Assuming that the company continues with its present production setup:
Compute the break-even point in sales dollars (2.5 pts.)
Prepare a contribution format Income Statement  for each of the next three years (2015 – 2017) using projected sales as follows (these figures assume a 10 percent growth rate in sales each year):  (5 pts.)
Year Sales 2015 $ 4,400,000 2016   4,840,000 2017   5,324,000
Year Sales 2015 $ 4,400,000 2016   4,840,000 2017   5,324,000
Year Sales
Year
Year
Sales
Sales
2015 $ 4,400,000
2015
2015
$ 4,400,000
$ 4,400,000
2016   4,840,000
2016
2016
  4,840,000
  4,840,000
2017   5,324,000
2017
2017
  5,324,000
  5,324,000

Assume that cost behavior patterns remain stable over the three-year period.
Refer to the computations in (b) above. Compute the operating leverage and the margin of safety percentage for each year.   (2.5 pts.)
Refer to the computations in (b) above. Compute the operating leverage and the margin of safety percentage for each year.   (2.5 pts.)

At what sales level will the 12 percent target profit on sales be achieved if the company keeps its old plant? How long does it appear that it will take the company to reach this sales level?  (2.5 pts.)

Based on the data in (1) – (4) above, evaluate the risks and merits of building the new plant and recommend to management the course of action that you think should be taken. (10 pts.)
Based on the data in (1) – (4) above, evaluate the risks and merits of building the new plant and recommend to management the course of action that you think should be taken. (10 pts.)
Criteria for Assessment of Essay:
-The risks and merits of each choice were mentioned       1 2 3 4 5
-A choice was recommended to management                    1 2 3 4 5

Individual Participation Points:  (20 pts.) These points will be awarded based  on the activity on your team’s Canvas discussion board. If you interact outside  of the Canvas discussion board leave me a message on your discussion board  indicating who was involved in the interaction.
Individual Participation Points:  (20 pts.) These points will be awarded based  on the activity on your team’s Canvas discussion board. If you interact outside  of the Canvas discussion board leave me a message on your discussion board  indicating who was involved in the interaction.

Please show computations.
Please show computations.

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