Sweats Galore case study

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Question: Sweats Galore case study After graduating from Eastern University in Campus Town, USA with a degr…
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After graduating from Eastern University in Campus Town, USA
with a degree in business, Michael Woods realized that he wanted to
remain in Campus Town. After a number of unsuccessful attempts at
getting a job in his discipline, Michael decided to go into
business for himself. In thinking about his business venture,
Michael determined that he had four criteria for the new
business.

First, he wanted to do something that he would enjoy.

Second, he wanted a business that would give back to the
community.

Third, he wanted a business that would grow and be more
successful every year.

Fourth, realizing that he was going to have to work very hard,
Michael wanted a business that would generate a minimum net income
of $25,000 annually.

While reflecting on the criteria he had outlined, Michael, who
had been president of his fraternity and served as an officer in
several other student organizations, realized that there was no
place in Campus Town to have custom sweatshirts made using a
silk-screen process. When student organizations wanted sweatshirts
for their members or to market on campus, the officers had to make
a trip to a city 100 miles away to visit “Shirts and More.” Michael
had worked as a part-time employee at Shirts and More while he was
in high school and had envisioned owning such a shop. He realized
that a sweatshirt shop in Campus Town had the potential to meet all
four criteria he had set. Michael set up an appointment with Jayne
Stoll, the owner of Shirts and More, to obtain information useful
in getting his shop started. Because Jayne liked Michael and was
intrigued by his entrepreneurial spirit, she answered many of
Michael’s questions.

In addition, Jayne provided information concerning the type of
equipment Michael would need for his business and the average
useful life. Jayne knows a competitor who is retiring and would
like to sell his equipment. Michael can purchase the equipment at
the beginning of 2006 and the owner is willing to give him terms of
50 percent due upon purchase and 50 percent due the quarter
following the purchase. Michael will purchase the following
equipment January 1, 2006:

Cost

Useful

Life

Hand operated press that applies ink to the shirt

$7,500

5 yrs

Light exposure table

1,350

10 yrs

Dryer conveyer belt that makes ink dry on the shirts

2,500

10 yrs

Computer with graphics software and color printer

3,500

4 yrs

Display furniture

2,000

10 yrs

Used cash register

500

5 yrs

Michael has decided to use the sweatshirt supplier recommended
by Jayne. He learned the cost of a gross of good quality
sweatshirts to be silk-screened would be $1,440.

Jayne has encouraged Michael to ask the sweatshirt supplier for
terms of 40 percent of a quarter’s purchases to be paid in the
quarter of purchase with the remaining 60 percent of the quarter’s
purchases to be paid in the quarter following the purchase.

Michael also learned from talking with Jayne that the ink used
in the silk-screen process costs approximately $.75 per shirt.

Knowing that the silk-screen process is somewhat labor
intensive, Michael plans to hire six college students to help with
the silk-screen process with each one working an average of 20
hours per week for 50 weeks during the year. Total annual wages for
the workers is estimated to be $72,000.

In addition, Michael will need one person to take orders, bill
customers, and operate the cash register. Cary Sue Smith, who is
currently Director of Student Development at Eastern University,
has approached Michael about a job in sales. Cary Sue knows the
officers of all of the student organizations on campus. In
addition, she is very active in the community. Michael thinks Cary
Sue can bring in a lot of business. In addition she also has the
clerical skills needed for the position. Because of her contacts,
Michael is willing to pay Cary Sue $1,200 per month plus a
commission of 10 percent of sales. Michael estimates Cary Sue will
spend 50 percent of the workday focusing sales, while the remaining
50 percent will be spent on clerical and administrative duties.

Michael realizes that he will have difficulty in finding a
person skilled in computer graphics to generate the designs to be
printed on the shirts. Jayne recently hired a graphics designer in
that position for Shirts and More at a rate of $500 per month plus
$.10 for each shirt printed. Michael believes he can find a
university graphics design student to work for the same rate Jayne
is paying her designer.

Michael was fortunate in finding a commercial building for rent
near the University and the downtown area. The landlord requires a
one-year lease. Although the monthly rent of $1,000 is more than
Michael had anticipated paying, the building is nice, has adequate
parking, and there is room for expansion. Michael anticipates that
75 percent of the building will be used in the silk-screen process
while 25 percent will be used for sales.

Michael’s fraternity brothers have encouraged him to advertise
weekly in the Eastern University student newspaper. Upon inquiring
Michael found that a 3” x 3” ad would cost $25 per week. Michael
also plans to run a weekly ad in the local newspaper that will cost
him $75 per week.  

Michael wants to sell a large number of quality shirts at a
reasonable cost. He estimates the selling price of each customized
shirt to be $16. Jayne has suggested that he should ask customers
to pay for 70 percent of their purchases in the quarter purchased
and pay the additional 30 percent in the quarter following the
purchases.

After talking to the insurance agent and the property valuation
administrator in his municipality, Michael estimates that the
property taxes and insurance on the machinery will cost $2,240
annually, while property tax and insurance on display furniture and
cash register will total $380 annually.

Jayne reminded Michael that maintenance of the machines is
required for the silk-screen process. In addition, Michael realizes
that he must consider the cost of utilities.   The
building Michael wants to rent is roughly the same size as the
building occupied by Shirts and More. In addition, Shirts and More
sells approximately the same number of shirts Michael plans to sell
in his store. Therefore, Michael is confident that the maintenance
and utility costs for his shop will be comparable to the
maintenance and utility costs for Shirts and More, which have been
observed as follows within the relevant range of zero to 8,000
shirts.

Shirts Sold

Maintenance Cost

Utility Cost

January

2,000

$1,716

$1,100

February

2,110

1,720

1,158

March

2,630

1,740

1,171

April

3,150

1,740

1,198

May

5,000

1,758

1,268

June

5,300

1,818

1,274

July

3,920

1,825

1,205

August

2,080

1,780

1,117

September

8,000

1,914

1,400

October

6,810

1,860

1,362

November

6,000

1,855

1,347

December

3,000

1,749

1,193

Michael estimates the number of shirts to be sold in the first
five quarters, beginning January 2006, to be:

First quarter year 1

8,000

Second quarter year 1

10,000

Third quarter year 1

20,000

Fourth quarter year 1

12,000

First quarter year 2

18,000

Seeing how determined his son was to become an entrepreneur,
Michael’s father offered to co-sign a note for an amount up to
$20,000 to help Michael open his sweatshirt shop, Sweats
Galore.   However, when Michael and his father approached
the loan officer at First Guarantee Bank, the loan officer asked
Michael to produce the following budgets for 2006:

Sales budget

Schedule of expected collections from customers

Shirt purchases budget

Schedule of expected payments for purchases

Silk-screen labor budget

Selling & administrative expense budget

Silk-screen overhead budget

Budgeted income statement

Cash budget

Budgeted balance sheet

The loan officer advised Michael that the interest rate on a
12-month loan would be 8 percent. Michael expects the loan to be
taken out January 1, 2006.

Michael has estimated that his income tax rate will be 20
percent. He expects to pay the total tax due when his returns are
filed in 2007.

Answer each of the following questions.

1) Do you think it was important for Michael to stipulate that
he wanted a business that he would enjoy, that would give back to
the community, that would grow and be more successful every year,
and that would generate a net income of $25,000
annually?   Why or why not?

2) If Michael has sales of $12,000 during January of his first
year of business, determine the amount of variable and fixed costs
associated with utilities and maintenance using the high-low method
for each.

3) Using the format below, prepare a Sales Budget for the year
ending 2006.

Sweats Galore

Sales Budget

For the Year Ending December 31, 2006

Quarter

1

2

3

4

Year

Expected unit sales

Unit selling price

X         

Budgeted sales revenue

$

4) Prepare a Schedule of Expected Collections from Customers

Sweats Galore

Schedule of Expected Collections from
Customers

For the Year Ending December 31, 2006

Quarter

1

2

3

4

Accounts Receivable 1/1/06

– 0 –

First quarter

Second quarter

Third quarter

Fourth quarter

Total collections

5) Michael learned from talking with Jayne that the supplier is
so focused on making quality sweatshirts that many times the shirts
are not available for several days. She encouraged Michael to
maintain an ending inventory of shirts equal to 25 percent of the
next quarter’s sales.

Prepare a Purchases Budget for shirts using the format
provided.

Sweats Galore

Shirt Purchases Budget

For the Year Ending December 31, 2006

Quarter

1

2

3

4

Year

Shirts to be silk-screened

Plus desired ending inventory

Total shirts required

Less beginning inventory

Total shirts needed

Cost per shirt

Total cost of shirt purchases

6) Prepare a Schedule of Expected Payments for Purchases.

Sweats Galore

Schedule of Expected Payments for Purchases

For the Year Ending December 31, 2006

Quarter

1

2

3

4

Accounts Payable 1/1/06

– 0 –

First quarter

Second quarter

Third quarter

Fourth quarter

Total payments

7) Prepare a Silk-screen Labor Budget.

Sweats Galore

Silk-screen Labor Budget

For the Year Ending December 31, 2006

Quarter

1

2

3

4

Year

Units to be produced

Silk-screen labor hours per unit

Total required silk-screen labor hours

Silk-screen labor cost per hour

Total silk-screen labor cost

8) Prepare a Selling and Administrative Expense Budget for
Sweats Galore for the year ending December 31, 2006.

Sweats Galore

Selling and Administrative Expense Budget

For the Year Ending December 31, 2006

Quarter

1

2

3

4

Year

Variable expenses

   Sales commissions

Total variable

Fixed expenses

   Advertising

   Rent

   Sales salaries

   Office salaries

   Depreciation

   Property taxes and insurance

Total fixed

Total selling and administrative expenses

9) Prepare a Silk-screen Overhead Budget for Sweats Galore for
the year ending December 31, 2006.

Sweats Galore

Silk-screen Overhead Expense Budget

For the Year Ending December 31, 2006

Quarter

1

2

3

4

Year

Variable costs

   Ink

   Maintenance

   Utilities

   Graphics design

Total variable

Fixed costs

   Rent

   Maintenance

   Utilities

   Graphics design

   Property taxes and insurance

   Depreciation

Total fixed

Total silk-screen overhead

Direct silk-screen hours

Overhead rate per silk-screen hour

10) Using the information found in the case and the previous
budgets, prepare a Budgeted Income Statement for Sweats Galore for
the year ended December 31, 2006.

Sweats Galore

Budgeted Income Statement

For the Year Ending December 31, 2006

Sales

Cost of goods sold

Gross profit

Selling and administrative expenses

Income from operations

Interest expense

Income before income taxes

Income tax expense

Net income

11) Using the information found in the case and the previous
budgets, prepare a Cash Budget for Sweats Galore for the year ended
December 31, 2006.

Sweats Galore

Cash Budget

For the Year Ending December 31, 2006

Quarter

1

2

3

4

Year

Beginning cash balance

Add: Receipts

Collections from customers

Total available cash

Less: Disbursements

Payments for shirt purchases

Silk-screen labor

Silk-screen overhead

Selling and administrative expenses

Payment for equipment purchase

Total disbursements

Excess (deficiency) of available cash over disbursements

Financing

Borrowings

Ending cash balance

12) Using the information contained in the case and the previous
budgets, prepare a Budgeted Balance Sheet for Sweats Galore for the
year ended December 31, 2006.

Sweats Galore

Budgeted Balance Sheet

December 31, 2006

Assets

Cash

Accounts receivable

Sweatshirt Inventory

Equipment

Less: Accumulated depreciation

Total assets

Liabilities and Owner’s Equity

Accounts payable

Note payable

Interest payable

Taxes payable

Total liabilities

Michael Woods, Capital

Total liabilities and owner’s equity

13) a) Using the information contained in the case and the
previous budgets, calculate the estimated contribution margin per
unit for 2006.

b) Calculate the total estimated fixed costs for 2006 (including
interest and taxes).

c) Compute the break-even point in units and dollars for
2006.

14) a) Michael is very disappointed that he did not have an
income of $25,000 for his first year of budgeted operations as he
had wanted. How many shirts would Michael have to sell in order to
have a profit of $25,000?

b) Why does Michael’s net income differ from his ending cash
balance?

15) Do you think it was a good idea to offer Cary Sue a salary
plus 10 percent of sales? Why or why not?

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