Baldwin Bicycle Company Case Study Solution
The current debt cost of “Baldwin Company” is higher because of the high debt ratio in the capital structure of the company.
The company’s weighted average cost of capital is higher than the current capital structure, which indicates that the company should not launch the “challenger bike”, because, it will increase the cost of financing for the company.
By analyzing the cost of financing with the contribution margin of the company; the company can have higher cost of financing as compared to the returns. Hence, the company has higher chances of incurrence of loss if it accepts the special order of “challenger bikes” as shown in Exhibit 5.
EXHIBITS
Exhibit 1:
| key financial indicators of Baldwin Bicycles | |
| Total current assets | $ 4,457,000.00 |
| Total current liabilities | $ 3,478,000.00 |
| working capital | $ 979,000.00 |
| Current ratio | 1.28 |
| Quick ratio | 0.49 |
| Debt to equity ratio | 1.61 |
| Return on Equity | 0.08 |
| Accounts payable turnover | 21 |
| Estimated raw material purchased | |
| last year volume units | 7500000 |
| unit cost of raw material | $1.07 |
| material purchased | $ 10,726,666.67 |
Exhibit 2:
| Total variable cost of making bike | ||
| unit cost | ||
| material | $ 39.80 | |
| labor | $ 19.60 | |
| variable Overhead cost | $ 9.80 | |
| Annual variable overhead cost of assets | ||
| pretax cost of funds | $ 244,620.00 | $ 0.82 |
| record keeping cast | $ 13,590.00 | $ 0.05 |
| Inventory insurance | $ 8,268.00 | $ 0.03 |
| Sales property tax on inventory | $ 19,292.00 | $ 0.06 |
| Inventory handling labor and equipment | $ 19,173.00 | $ 0.77 |
| pilferage , obsolesce, breakage | $ 13,780.00 | $ 0.05 |
| Total variable cost per unit of making bike | $71 | |
| Monthly cost | Bikes | |
| Raw material (two months supplies) | 4000 | $ 283,862 |
| Work in process | 1000 | $ 70,965 |
| finished goods | 500 | $ 35,483 |
| cost of bikes kept in factory | ||
| Raw material (two months supplies) | 3000 | $212,896 |
| Work in process | 500 | $35,483 |
Exhibit 3:
| Monthly average accounts receivable | |
| Sales | $ 46,145 |
| selling price | $ 92.29 |
| units | 500 |
| accounts receivable turn over days | 30 |
| credit sales percentage | 17% |
| net credit sales | $ 7,750 |
| Estimated accounts receivables | $646 |
| Monthly average accounts payable | |
| purchases | $35,483 |
| cost | $71 |
| units | 500 |
| accounts payable turn over days | 21 |
| credit purchase percentage | 6% |
| net credit purchase | $2,245.08 |
| Estimated accounts payable | $131 |
Exhibit 4:
| Estimation of Baldwin’s monthly investment in working capital | |||
| lower end | $652,667 | ||
| higher end | $1,468,500 | ||
| Existing working capital | $979,000 | ||
| Additional working capital required | $489,500 | ||
| WACC | |
| Debt cost | 18% |
| Equity cost | 15% |
| Debt ratio | 62% |
| Equity cost | 38% |
| tax | 50% |
| Baldwin’s WACC before launching challenging bikes | 11% |
| WACC of additional capital | |
| debt | 33% |
| equity | 67% |
| Debt cost | 18% |
| Equity cost | 15% |
| tax | 50% |
| WACC for additional capital | 13% |
| Total financing cost for raising additional funds | |
| Total debt | $5,153,167 |
| Total equity | $3,428,333 |
| Total assets | $8,581,500 |
| debt ratio | 60% |
| equity ratio | 40% |
| debt cost | 18% |
| equity cost | 15% |
| tax | 50% |
| WACC | 11% |
| Total cost of financing | $978,035 |
Exhibit 5:
| Contribution margin | |
| units | 25000 |
| sales | $ 2,307,250 |
| variable cost | $1,774,136 |
| contribution margin | $ 533,115 |
| contribution margin per unit | $21 |
| contribution margin percentage | 23% |
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