Mile High Cycles

Assignment Questions

Bob Myer prepared a budget for Mile High Cycles (MHC) at the beginning of year 2004. In the budget, he envisaged a production of 10,000 cycles and forecast possible production costs, both direct and overheads. Additional demand saw MHC producing 10,800 cycles i.e. 8% more than the budget. Simultaneously, total cost of production exceeded the budget of $10,895,000 to reach $11,969,787, which was roughly 9.86% more than the budget. Appendix-I provides the detailed flexible budget that shows what total costs would have been had MHC produced 10,800 cycles at similar per unit cost as budgeted. The summary shown below (Table-1) indicates that if MHC could maintain the estimated expenses, they would have produced the 10,800 cycles at an individual cost of $1,084, which is $6 lower than the budget of $1,090. This $6 would have meant an addition of $56,000 to their bottom line.

Cost Particulars Budgeted Costs

Flexible Budget

Cost

Frame Assembly 4,825,000 5,211,000

Wheel Assembly 1,265,000 1,366,200

Final Assembly 3,605,000 3,893,400

Var. Other Costs 500,000 540,000

Total Variable Cost 10,195,000 11,010,600

Fixed Costs 450,000 450,000

Fixed Other Costs 250,000 250,000

Total Fixed Costs 700,000 700,000

Total Cost 10,895,000 11,710,600

Total Cost per Bike 1,090 1,084

Table-1: Flexible Budget for Increased Production

(All numbers in $)

However, the actual production costs were higher than the flexible budget and totaled $11,969,788 or $1,108 per cycle. Appendix-II shows detailed calculations of the actual costs compared to the flexible budget. The appendix also shows the variances on individual scores as calculated. The variances consist of two parts. The first is the variance due to change in the ‘per-unit’ costs of materials and labor and the second is the increase in costs due to lower efficiency of utilization of inputs. An additional element of rework parts appears that Bob had not accounted for while preparing the budget. This alone added $70,000 to the total expenses – a number that accounts for

about 27% of the total variance in costs. Table-2 below provides a summary of the variance calculations.

Cost ParticularsFlexible Budget Actual Results Variance

Cost Cost Total Efficiency PriceFrame Assembly - Steel Tubing 3,564,000 3,572,100 -8,100 162,000 -170,100 - Paint 27,000 28,188 -1,188 -500 -688 - Labor 1,620,000 1,528,050 91,950 117,000 -25,050Total - Frame 5,211,000 5,128,338 82,663 278,500 -195,838Wheel Assembly - Parts 1,296,000 1,317,600 -21,600 -21,600 - Rework Parts 25,000 -25,000 -25,000 - Labor 70,200 74,250 -4,050 -1,300 -2,750Total - Wheel 1,366,200 1,416,850 -50,650 -1,300 -49,350Final Assembly - Parts 3,780,000 3,963.600 -183,600 -183,600 - Rework Parts 45,000 -45,000 -45,000 - Labor 113,400 116,000 -2,600 1,400 -4,000Total - Assembly 3,893,400 4,124,600 -231,200 1,400 -232,600Var. Other Costs 540,000 600,000 -60,000 -60,000Total Variable Cost 11,010,600 11,269,788 -259,188 278,600 -537,788 Fixed Costs 700,000 700,000 Total Cost 11,710,600 11,969,788 -259188 Total Cost per Bike 1084 1108 -24

Appendix-I: Flexible Budget

Cost Particulars

Initial Budget Flexible BudgetOutput 10,000 Bikes Output 10,800 Bikes

Quantity Rate CostInput

Efficiency Quantity Rate CostFrame Assembly - Steel Tubing 110,000 $30 $3,300,000 11 118,800 $30 $3,564,000 - Paint 1,250 $20 $25,000 0.125 1,350 $20 $27,000 - Labor 100,000 $15 $1,500,000 10 108,000 $15 $1,620,000 Total - Frame $4,825,000 $5,211,000

Wheel Assembly - Parts 10,000 $120 $1,200,000 1 10,800 $120 $1,296,000 - Rework Parts - Labor 5,000 $13 $65,000 5,400 $13 $70,200 Total - Wheel $1,265,000 $1,366,200

Final Assembly - Parts 10,000 $350 $3,500,000 1 10,800 $350 $3,780,000 - Rework Parts - Labor 7,500 $14 $105,000 1 8,100 $14 $113,400 Total - Assembly $3,605,000 $3,893,400 Total Variable Cost $9,695,000 $10,470,600

Fixed Costs - Rent $250,000 $250,000 - Office Staff $100,000 $100,000 - Depreciation $100,000 $100,000

Total Fixed Costs $450,000 $450,000 Other Costs - Fixed Portion (1/3) $250,000 25 $250,000 - Variable Portion (2/3) $500,000 50 $540,000 Total Other Costs $750,000 $790,000 Total Annual Costs

- Variable $10,195,00

0 $11,010,600 - Fixed $700,000 $700,000

Total Cost $10,895,00

0 $11,710,600 Cost Per Bike - Variable $1,020 $1,020 - Fixed $70 $65 Total Cost per Bike $1,090 $1,084

Cost Particulars Flexible Budget Actual Results Variance Variance divisionOutput 10,800 Bikes Output 10800 Bikes Efficiency Price

Quantity Rate Cost Quantity Rate Cost TotalFrame Assembly - Steel Tubing 118,800 $30 $3,564,000 113,400 $32 $3,572,100 -$8,100 $162,000 -$170,100 - Paint 1,350 $20 $27,000 1,375 $21 $28,188 -$1,188 -$500 -$688 - Labor 108,000 $15 $1,620,000 100,200 $15 $1,528,050 $91,950 $117,000 -$25,050 Total - Frame $5,211,000 $5,128,338 $82,663 $278,500 -$195,838

Wheel Assembly - Parts 10,800 $120 $1,296,000 10,800 $122 $1,317,600 -$21,600 -$21,600 - Rework Parts $25,000 -$25,000 -$25,000 - Labor 5,400 $13 $70,200 5,500 $14 $74,250 -$4,050 -$1,300 -$2,750 Total - Wheel $1,366,200 $1,416,850 -$50,650 -$1,300 -$49,350

Final Assembly - Parts 10,800 $350 $3,780,000 10,800 $367 $3,963,600 -$183,600 -$183,600 - Rework Parts $45,000 -$45,000 -$45,000 - Labor 8,100 $14 $113,400 8,000 $15 $116,000 -$2,600 $1,400 -$4,000 Total - Assembly $3,893,400 $4,124,600 -$231,200 $1,400 -$232,600 Total Variable Cost $10,470,600 $10,669,788 -$199,188 $278,600 -$477,788

Fixed Costs - Rent $250,000 $250,000 - Office Staff $100,000 $100,000 - Depreciation $100,000 $100,000

Total Fixed Costs $450,000 $450,000 Other Costs - Fixed Portion (1/3) $250,000 $250,000 - Variable Portion (2/3) $540,000 $600,000 -$60,000 Total Other Costs $790,000 $850,000 -$60,000 Total Annual Costs - Variable $11,010,600 $11,269,788 -$259,188 - Fixed $700,000 $700,000 Total Cost $11,710,600 $11,969,788 -$259,188 Cost Per Bike - Variable $1,020 $1,043 -$24 - Fixed $65 $65

The transition in customer preferences from 10-speed road bikes to the 15 to 21-speed mountain bikes for not only mountain and dirt track biking but also for city use marks the most important aspect of Mile High Cycles’ (MHC) business scenario. Entry into this business at the appropriate time allowed the company to exceed its target of 10,000 bikes in the first year of operations by as many as 800 bikes. A key aspect of the business is the knowledge and passion for cycling the owner Bob Moyer brings to the business. He is a graduate in mechanical engineering and is an avid cyclist who represented Stanford University while in college.

The manufacturing process for the bikes appears straightforward as MHC manufactures only the frames in its factory. The other processes of wheel assembly and final assembly require labor for giving the wheels and the bikes a final shape. MHC manufactures its own frames by cutting steel tubing to precise size, shaping them, and welding individual components together before painting. Strict quality control through frequent inspections and measurements marks the process. MHC uses an automatic lacing and truing machine to build the wheels from spokes, rims, and hubs sourced from an outside supplier. Some damages take place during the insertion of the spokes and correcting machine errors requires manual effort. Skilled workers take up the task of final truing and inspection of the wheels before passing them on to the final assembly shop. Using the frames and wheels and a host of other components and sub-assemblies purchased from outside suppliers the assembly shop personnel put together the final package for delivery to bicycle dealers. The cycles do not take final shape here because, in an effort to reduce damage during transit, MHC packs some of the components as such, which the dealers assemble themselves before selling to the ultimate customer.

In the first year MHC produced only one model of mountain bike painted in ten different color schemes. This could act as a constraint for future increase in sales. A distinct market exists for DIY kits for customization of 10-speed bikes. As volumes grow, MHC would need to consider backward integration of its manufacturing facility to include some of the parts and sub assemblies it presently buys from outside vendors. Adding more models, customization/upgrade kits, and backward integration will help expand business but will add greater complexity to manufacturing processes and inventory management.