Golden State Elixirs' tinctures are produced in four steps: extraction, blending, testing, and bottling. The first step

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Golden State Elixirs' tinctures are produced in four steps: extraction, blending, testing, and bottling. The first step is the extraction of cannabis oil from cannabis buds, also called cannabis flower. Only the buds contain the active ingredients. Golden State Elixirs has developed a propriety extraction technology that leaves minimal chemical byproducts in the oil. The purer the oil, the fewer potential side effects from the medicine. Depending on the cannabis strain, 8 oz. of cannabis flower costs between US$300 and US$900, with an average cost of US$460. For each 8 oz. of cannabis flower, the propriety process uses US$35 of materials. Depending on the strain, the extraction process generates between 3 and 14 oz. of cannabis extract, with an average of 8 oz. of cannabis extract. The second step is blending. Different cannabis strains have different effects. For example, AC/DC reduces pain, chocolate catatonic alleviates anxiety, and critical kush helps with insomnia. The master blender, Akasha, combines the extracts from several strains to create a tincture with the required effect. While each tincture is a blend, she always generates 8 oz. of the combined extracts. The 8 oz. of cannabis extract are mixed with 52 oz. of medium chain triglycerides (MCT) oil to generate 60 oz. of tincture extract.10 A 64-oz. bottle of MCT oil costs US$26. Once the blending is complete, the tincture batch is tested for levels of the two active ingredients: cannabidiol (CBD) and tetrahydrocannabinol (THC). The testing results are then added to the generic label. Testing costs US$60 for each set of 60 bottles. The final step is bottling, labeling, and packing. One oz. of tincture mixture is poured into each bottle. The bottles are wiped, a dropper inserted, and a label added. Tinctures are then placed into boxes that hold 10 bottles. Bottles and stoppers cost

US$0.25 each, while labeling costs US$0.40 a bottle. Each box costs US$1.25. A box filled with completed tincture bottles is termed a case. There are several monthly fixed costs. Rent is US$400, amortization of tools is US$350, and marketing (i.e., website, t-shirts, magnets) costs US$250. While different products have different prices, on average, a bottle of tincture sells for US$30. The owners of Golden State Elixirs do not currently charge for labor. Their process takes about 10 hours to make a batch of six cases. Golden State Elixirs is a startup and has been growing. Its sales by case for the previous 12 months are provided in Table 1. They conjecture that they could continue to grow at the same rate for three years before being running into problems.

Table 1: Golden State Elixirs Sales for 2017

Month Sales in Cases

January 5.0

February 5.1

March 5.4

April 7.5

May 7.7

June 7.6

July 10.0

August 10.5

September 12.3

October 12.8

November 13.0

December 13.7

LICENSE INFORMATION AND TAXES

There are two distinct sets of licenses required for Golden State Elixirs to be able to operate legally under California law: a local city license and a state license. There is no city license application fee, and the yearly cost of a local city license is US$50. Once a city license is obtained, the city levies a 5% excise tax. This is not an income tax but rather a tax on gross revenues. The California cannabis regulations are similar to those governing wine production and sales. There is an audited "chain of custody" from the ground to the consumer with multiple sets of taxes collected along the way. Obtaining a state license involves many distinct steps, such as creating architectural drawings showing the security cameras and access restrictions, demonstrating that the company has an industrial safe that can hold the cannabis, and providing an audit trail for all purchases and sales of cannabis. Many of these requirements involve filling in forms and, given that the partners in Golden State Elixirs work for nothing, this part can be valued at zero. Yet roughly 90 hours would be required to fill in the forms. The additional costs shown in Table 2 would have to be incurred to obtain a yearly California license.

Table 2. Additional Costs to Golden State Elixirs

Application fee $ 1,000

Microbusiness license fee $ 5,000

Professional drawings $ 1,500

Surety bond $ 5,000

Liability insurance $ 800

Total State License Costs $13,300

Although California levies additional taxes on cultivators and final distributors, there are no additional excise taxes on cannabis manufacturers.11 California, however, has an 8.8% business income tax. In California, all canna-business expenses are tax deductible. While canna-businesses are illegal under federal law, they still have to pay federal taxes. There is a special rule (Internal Revenue Code 280E) that governs calculating an illegal business' income. For illegal businesses, only cost of goods sold (COGS) is a federal tax-deductible expense. In particular, selling, general, and administrative expenses and interest expenses are not tax deductible. This restriction results in canna-businesses paying much higher federal taxes than other businesses. Currently Golden State Elixirs has a federal tax rate of 21%.

Question: Ignoring all taxes, calculate the breakeven number of cases for 2017. Remember that no licensing costs were incurred in 2017. HINT: find the variable costs per batch, then scale up or down as needed. Provide summary calculations (you can paste in from excel) to support your answer.