FINANCIAL MANAGEMENT

Case Analysis
TIP-TOP TOY COMPANY, INC.
Profit Planning and Break-Even Analysis
Overview
 Tip-Top Toy Company was established in 1975 by Janice Merritt, a master’s
degree holder in child development and a certified teachers, Tom Merritt, the
husband of Janice a former sales representative for an industrial goods
manufacturer and her father Roy Magruder. a retired production superintendent
of a furniture manufacturer and assumed responsibility for manufacturing
operations in the new toy company. With the Merritt’s limited savings and a
major investment by Roy Magruder , the Midland State Bank loaned short-term
working capital funds to assist in starting the business.

 The Tip-Top product line included wooden puzzles, gym equipment, blocks, and
wooden cars and trucks. Despite the enthusiasm of the new entrepreneurs, the
early years of the business provided only limited financial success. But after
many frustrating incidents, the efforts of Tip-top founders began to pay off. Their
quality and competitive low prices attracted considerable attention among toy
shops and department stores in the region. By the third year of its existence, the
company operated at a profit, and the Merritts were able to increase their
salaries to an amount more nearly commensurate with their work efforts.
Overview
 Janice Merritt, was approached in January 1985 by a chain-store buyer and
asked to produce a variety of wooden toys for the chain store for the 1985
Christmas season. The order would assure that Tip-Top would operate at or
near capacity through October. Since shipments to the chain store could begin
in the summer, it was possible that last-minute reorders by the chain could
continue near-capacity operations into early December.

 The chain-store buyer asked for a quotation on 12,000 toy units with the
composition of the order to be essentially the same proportion among various
toy items as Tip-Top had produced in 1984. Instead of carrying the Tip-Top label,
the toys would be branded with chain store’s name but would be similar in all
other respects to current products. The buyer made it clear that price was an
important factor in deciding whether Tip-Top would get the order. The chain
store management would expect the usual high Tip-Top quality. Some of the
toys would be sold outside Tip-Top’s present territory, but some would be
marketed in communities where Tip-Top toys were now being sold.
Overview
 Sales and profits in 1984 reached a high for the company, with sales of
$350,000 and profits after taxes of $22,000. Some toy manufacturers operated
at a loss in the last quarter of the year because of price cutting on promotional
items. Although the long-term outlook was good for staple toy items such as
those produced by Tip-Top, many toy buyers for major stores were cautious in
making early commitments for 1985. Despite this uncertainty in the market,
Janice Merritt was confident that 1985 sales would exceed 1984 without taking
the new proposed contract into account. By hiring a few more workers, the
company’s facilities could increase unit sales by 25%.

 Tip-Top’s income statement for 1984 is summarized in Exhibit 1. The Merritts

estimated that selling, general, administrative expenses would be fixed at about
$107,000 for 1985. An estimated $43,000 of the cost of goods sold in 1984 were
fixed costs. Management believed that the fixed portion of cost of goods sold in
1985 would be about $47,000.
Overview

 Approximately 60,000 toy units were sold in 1984. Variable costs of production
for the Merritt’s toy line depended on the specific items. However, in 1984
variable costs for the product line as a whole averaged $2.90 per unit. Because
of the high productivity of their employees, the Merritt’s believed average unit
variable costs per unit would remain about the same in 1985 even though hourly
wages would be slightly higher.
Overview
 Without the new chain-store, Janice Merritt forecast 1985 sales of about 63,000
units, an increase of five percent over 1984. These sales would be to
established customers with some minimal allowance for new business. Because
of competition, the Merritts could not raise prices to their regular customers
more than five percent in 1985. Tip-Top’s 1984 selling price averaged $5.83 per
unit. In 1984 no single customer accounted for more than five percent of Tip-
Tops sales.
Problem
 Should Tip-Top Company, Inc. accept the 12,000 toy units order from the
chain-store

Objective
 Increase of 5% sales in 1985 or more over the 1984 as forecasted by Janice
Merrit

Areas of Consideration

 Number of employees to realize the increase of unit sales and its operation.

 Selling, general, administrative expenses, fixed cost and variable cost

 Tip-Top’s selling price per unit. Will retaining the price to its regular
customer can meet the target increase of 5% sales?
Areas of Consideration
 If order is accepted from the chain store:

* Should the Tip-Top Toy Company allow changing its label

instead it would be branded with the chain store name?

*Will there be an increase of price per unit or give the same

amount like the regular customers?

*Be sold in the same market where Tip-Top toys are selling.

Proposed Solution
Solve for Break-Even and Income Before Interest & Taxes

Breakeven Point (Units) = Total Fixed Costs/Unit CM

Breakeven Point (Dollars) = Total Fixed Costs/CM Rate

Breakeven Chart of the following:
5% increase in sales units = 63,000
5% increase in price per unit (5.83x5%) = $6.13
Variable Costs per unit = $2.90
Fixed Costs = $47,000

Sales Fixed Total Costs BEU aprox.=14574

$600,000

$500,000

$400,000
Unit Price

63000 Units,
$385,875 Sales
$300,000

$200,000
BEU = 14574,
$89,266
$100,000
Fixed Cost = $47,000

$0
0 10000 20000 30000 40000 50000 60000 70000 80000 90000
UNITS
Breakeven Chart of the following:
12% increase in sales units = 72,000
Price per unit = $5.83
Variable Costs per unit = $2.90
Fixed Costs = $51,395

Break Even Analysis

Sales Fixed Total Costs BEU aprox.=17541

$500,000

$450,000

$400,000 72000 Units,

$419,760 Sales
$350,000

$300,000
Unit Price

$250,000

$200,000

$150,000 BEU = 17541, $102,264

$100,000

$50,000 $51,395

$0
0 10000 20000 30000 40000 50000 60000 70000 80000 90000
UNITS
Proposed Solution
Earnings Before Interest and Taxes (EBIT)

1984 1985 CHAIN-STORE 1985

Units Sold $60,000 $63,000 $12,000 $72,000
Selling Price Per Unit $5.83 $6.13 $5.83 $5.83
Sales $350,000 $385,875 $69,960 $419,760
Variable Cost of Goods Sold $174,000 $182,700 $34,800 $208,800
Fixed Cost of Goods Sold $43,000 $47,000 $8,395 $51,395.20
Gross Income $133,000 $156,175 $26,765 $159,565
Selling, Gen & Admin Exps $98,000 $108,045 $19,589 $117,533
Operating Income EBIT $35,000 $48,130 $7,176 $42,032
38% 21% 20%

58%

Variable Cost Per Unit $2.90 $2.90 $2.90 $2.90

Fixed Cost 43000 47000 12% $51,395
Selling, Gen., & Admin. Exp. 28% 28% 28% 28%
Recommendation
 Tip-Top Company can increase 5% of the unit sales that is $ 63,000 provided
there should also a 5% increase in price per unit of $6.13 to realize a 38%
increase in EBIT from the 1984 operating income.

 The chain store order if accepted should be executed. It generates an EBIT

of about $7,176(21%) combined with 1985 of $48,130(38%) a total of
$55,306. An increase of 58% EBIT. But the following should be in
consideration:

 The price of 5.83 is given for the chain-store is to build a new customer.
 Selling of the toys in the same market is still acceptable since the
product came from the Tip-Top company.
 Selling of the toys outside Tip-Top’s present territory would mean
expanded market.
 In the case of changing the label of Tip-Top and make it branded with the
chain store’s name is unacceptable. The fact that the order would be
similar in all other respects to current product of Tip-Top there is a
possibility that the toys be replicated. Tip-Top Toys Comp. should protect
its legacy as well as its right to property.