Desert Valley Brewery Ltd. Harvard Case Solution & Analysis

Desert Valley Brewery Ltd Case Study Solution 

Situation

The Desert Valley Brewery is about to start its commercial business soon. It has planned the operations and budgets for such operations. However there were certain uncertainties which might affect the budgeted results. The sensitivity analysis will provide the estimation and the expected effects on the profitability of the business. This analysis will help to identify the impact of such uncertain events and its effect on the profit or contribution margin so that necessary measures can be taken to mitigates such risk.

Risk factors

There were two factors that are uncertain and might fluctuate in future. The fluctuation will affect the contribution margin.  First one is the raw material cost. The raw material cost is expected to be either higher or lower than anticipated in the budget. These raw materials include malting barley and wheat grain. It is more likely that the cost of these raw materials would go higher and will negatively impact the profit of the company.

Sensitivity Analysis for change in Raw Material Prices

It is indicated in the case that malting barley prices fluctuates between 20-30% over the prior year prices. Thus to make a sensitivity analysis we will use this threshold. We assume that the prices might either be increases by average 25% or be decrease by 25%. Thus using this analysis is made to identify the impact of such price change on the profitability of the company. Thus the prices of wheat and malting barley are increased to see what changes have been made. As per the analysis the increase in price decrease the profitability of the company. The increase in prices decrease the profit to 12.5%, 12.2% and 12.2% as a percentage of sales as compared to the budgeted percentages of 14.4%, 14.1% and 14.2% for year 2002,2003 and 2004.

Sensitivity analysis is made assuming the event if prices of wheat and barley goes down by 25%. In this event the profit of the company increases as the raw material or variable production cost decreases. As per this analysis the profit increases in same ratio as it was decreased due to the increased prices. Thus profit for the year 2002, 2003 and 2004 increases to 16.2%, 16% and 16.1% as a percentage of sales.

The overall analysis shows that the profitability is moderately sensitive to the prices of raw materials that are wheat and malting barley. The sensitivity is not that high such if it make the company to make loss or make its business suffer. One way to mitigate this risk is to make future fixed contract with the supplier, with the primary agreement to provide the raw materials at the fixed prices up to specified date. This will mitigate the risk of rising prices of raw material. However this will limit the company to get benefits from the decreased prices in future. However increase is more likely to occur, this option is best therefore for risk mitigation.

Sensitivity Analysis for change in Sales volume

As per the case, the beer market is in declining trend and the numbers of beer consumers are decreasing. But for relevant analysis we consider the data gathered from the six micro brewers that represent their startup operations. The data gathered represent the actual volume sales in the first year as compared to the budgeted sales volume. This shows that the volume is fluctuating in between the 20%-30%. While using the graph table and the available information on the six micro brewers, the average change is calculated to be 25%.

The sensitivity analysis performed for identifying how sensitive is net profit and contribution from the change in the sales volume. Thus an increase of sales volume is assumed to analyze the impact of increased volume, with 25% increase above the budgeted volume. The decrease of sales volume is assumed to analyze the impact of decreased volume, by decreasing the budgeted volume by 25%.

Thus the analysis shows that the Profit and contribution margin are highly sensitive to the sales volume. The increase of 25% in the budgeted volume will result in higher profit for the company. The profit over sales ratio increases to 25.4%, 15.5% and 15.5% for year 2002, 2003, and 2004 as compared to the base case or as per budget 14.4%, 14.1% and 14.2% for the same years. It is seen that in the first year of operation the net profit is higher as compared to other years. Subsequently the net impact is high in the first year than other years.

On the other hand the net impact of decreased sales volume indicates worse situation for the company. The decreased sales volume has resulted in reduction of profit and contribution margin has been decreased to 8.1%, 30.2% and 30.0% as compared to the base years 30.8%, 30.2% and 30%. While the net profit has become negative in the first year of operation, if sales volume is decreased. The net profit as a percentage of sales becomes -3.9%, 11.8% and 11.9%.

Desert Valley Brewery Ltd. Harvard Case Solution & Analysis

 

 

Therefore the overall analysis shows that the profitability is more sensitive and effected by the sales volume than raw material prices. One way to mitigate the risk of lower sales volume is to offer some discounts on the product such as promotional sales. Moreover some marketing strategies might also help to make the product prominent in the market. Company should offer discounted prices to bars, restaurants and should use sales representative in the first year to make the brand prominence and this also helps to achieve the required sales target.............

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