Baldwin Cycles
Case 26-4: Baldwin Bicycle Company*
Note: This case is unchanged from the Eleventh Edition
Approach
The broad issue in this case is the analysis of the profitability of a company’s sales to specific customers. Most differential cost cases dealing with incremental volume are such that the student can reasonably assume that the “great majority (if not all) of the differential cost items will be variable costs. In this instance, a possible medium-to-long term volume increase of 22 percent suggests that many costs that are fixed in the short term for small increments in volume may be differential for this proposal. Also, very few differential cost cases (other than capital budgeting cases) explicitly ask the student to deal with the additional administrative and holding costs (both added funds cost and other asset-related costs) associated with significant increases in receivables and inventories. Thus, this case presents a good bridge between the traditional short-run differential cost case and the typical capital budgeting analysis.
Comments on Questions
The typical student will present an analysis based on only variable costs’ being differential. For logical consistency, such a student should also base incremental asset holding costs on increases in assets related to variable costs. For example, if one assumes the incremental cost of a bike is $69.20, then one should increase finished goods inventory by $69.20 for one additional bike. Increasing inventory by the full cost of $83.90 is equivalent to charging holding costs on over absorbed overhead, rather than on the actual incremental economic investment.
Such an incremental analysis on an annual basis is shown below. Note that the 1988 gross margin of 26 percent is used to impute revenue of $113.38 per bike in the lost sales’ contribution analysis. Some students will use the 1988 average price ($10,872,000/98,791 = $110.05); but that is arguably too low, since 1988’s average unit full cost was $81.43
Note: This case is unchanged from the Eleventh Edition
Approach
The broad issue in this case is the analysis of the profitability of a company’s sales to specific customers. Most differential cost cases dealing with incremental volume are such that the student can reasonably assume that the “great majority (if not all) of the differential cost items will be variable costs. In this instance, a possible medium-to-long term volume increase of 22 percent suggests that many costs that are fixed in the short term for small increments in volume may be differential for this proposal. Also, very few differential cost cases (other than capital budgeting cases) explicitly ask the student to deal with the additional administrative and holding costs (both added funds cost and other asset-related costs) associated with significant increases in receivables and inventories. Thus, this case presents a good bridge between the traditional short-run differential cost case and the typical capital budgeting analysis.
Comments on Questions
The typical student will present an analysis based on only variable costs’ being differential. For logical consistency, such a student should also base incremental asset holding costs on increases in assets related to variable costs. For example, if one assumes the incremental cost of a bike is $69.20, then one should increase finished goods inventory by $69.20 for one additional bike. Increasing inventory by the full cost of $83.90 is equivalent to charging holding costs on over absorbed overhead, rather than on the actual incremental economic investment.
Such an incremental analysis on an annual basis is shown below. Note that the 1988 gross margin of 26 percent is used to impute revenue of $113.38 per bike in the lost sales’ contribution analysis. Some students will use the 1988 average price ($10,872,000/98,791 = $110.05); but that is arguably too low, since 1988’s average unit full cost was $81.43