Toy World Inc.
Jack McClintock must decide whether Toy World Inc. should adopt level monthly production or stay with the current seasonal production schedule.
Seasonal Production vs. Level Production
Mr.McClintock must consider the following conditions in order to make his decision:
• Income - What is the projected profitability under level production? How does it compare to seasonal production?
• Debt - What effect will level production have on the liquidity of the company’s financial obligations? Which method is better to reduce debt requirements?
• Loans - Can he negotiation additional loans if he needs supplementary income under level production?
• Risk - What risk factors are involved with adapting level production?
In order to compare the two production methods, a pro forma balance sheet, income statement and funding strategy has been derived for each production method using the 1994 projected monthly sales. Using the criteria above, we have chosen the best method of production for each requirement in order to help us make our final decision.
Income - Level Production
Based on income, level production is the best choice. Level production will eliminate overtime costs of $225K and direct labor costs of $265K, reducing the percentage of COGS from 70% to 65.1% of sales. A portion of these savings would be offset by higher storage costs of $115K, which will increase operating costs each month. However, even with these additional costs, net profit under level production is projected to be $520K, which is a 48% increase over the seasonal production estimate of $351K.
Debt - Seasonal Production
Seasonal production does not have the cash flow issues that occur under level production. The cost of level production of finished goods will be $543K each month; sales from January to July average $143K. These projected sales will not cover the cost of production, the company’s assets...