In 2009, David Tucker quit his job at a large beer company to start his own brewery,

Question:

In 2009, David Tucker quit his job at a large beer company to start his own brewery, Arizona Microbrewery, Inc. (AMI). His family supported his decision and invested in the business along with David. AMI began operations on January 10. 2010 and now produces four labels of specialty been (Saguaro Pale Ale, Bisbee Bock, Ocotillo Amber Pilsner, and Sedona Stout). An explanation of the beer-making process is shown in Appendix A.

In much of the United States (including Arizona), beer is sold in a "three-tier" system. Under this system, beer is manufactured by producers, sold to distributors, who then sell to retailers (such as liquor stores. drug stores, and grocery stores). David employs two salespeople who receive a fixed monthly salary plus an 8 percent commission. All beer is sold to beer distributors (primarily in the Southwestern United States) in cases of 24 bottles. Product sales and cost information for 2013 are shown in Exhibit 1 with additional information in Exhibit 2. David rents a facility that is used to make the beer, a refrigeration area to store the beer, and a small office area. AMI brewery has five machines with 9.300 total machine hours available per year to produce beer (assuming AMI remains on one shift with some normal maintenance. breaks. etc.). While there is an empty space in the facility that could be used to expand the beer operations, the company would need to purchase an additional grain hopper and brew house for about $100,000 (the current water system and process control system could be expanded to handle the new machine). As discussed in Appendix A, beers arc aged in a refrigeration area prior to sale. The current refrigeration unit allows for different temperatures in different areas of the unit and the unit is usually running about 80 percent full. Keeping the refrigeration unit somewhat full helps reduce refrigeration costs.1 Additionally, since the company is so new, sales have been growing but erratic (from 2010 to 2011. sales growth was over 45 percent; however. from 2012 to 2013, sales growth was only 12 percent). Thus, keeping more beer on hand allows the company to mat the erratic demand without loss of sales.

EXHIBIT 1

213 Cost and Sales Information

Panel A: Per Case Information

Ocotillo Bisbee Bock Amber Pilsner Saguaro Sedona Stout Total Pale Ale Sales Price Direct Materials per case Direct Labo

Panel B:Contribution Margin Income Statement

David has not taken a salary since the business started. While the business has been generating a small profit, David has been reinvesting the earnings in the business. He wants to grow the business to generate more profit for his family and himself. David has been considering increasing the price on Sedona Stout from $26.50 per case to $29.00 per case. He thinks that, with this price increase, unit sales will decrease from 4,184 cases to 3,750 races per year. However, this would only reduce total annual Stout revenues to $108,750 from $110,876. Alternatively, David could drop the price of Sedona Stout to $25 per case. This is much closer to the Bock price as well as the Pilsner. Based on his market research, he thinks that this will result in Stout sales increasing to 4,700 cases per year. He is leaning toward this alternative as this will increase Stout revenues from $110,876 to $117,500 per year.
While the company has some cash on hand, neither the company nor David's family have another $100,000 to invest in the business right now for a new grain hopper and brew house. Since the business is new and has been showing only small profits, David has not been able to get a loan to expand the business. Instead, David wants to fully utilize the machines they already have. In 2013, they used a little over 8,300 machine hours (as shown in Exhibit 1) and the existing five machines have a total of 9,300 machine hours available during the year (assuming normal maintenance and some repairs needed during the year). Thus, the existing machines have approximately 1,000 additional hours available for use. David wants to keep producing and selling all four of his product lines because many of the beer distributors like buying from breweries that offer several different beers.
EXHIBIT 2
Additional Cost Information
Panel A:Details of Total Variable Costs
Direct Materials.............................................$93,537.20
Direct Labor.................................................116,393.25
Production Supplies..........................................26,064.41
Variable Portion of Maintenance...........................40,892.55
Variable Portion of Utilities.................................27,610.57
Variable Office Supplies (sales forms, etc.)................3,493.88
Shipping Costs................................................31,619.19
8% Sales Commission.......................................56,828.04
Total Variable Costs......................................$396,439.09
Panel B:Details of Total Fixed Cost (Direct and Indirect)
Brew Master/Quality Control Manager ................................. $60,293.15
Receiving and Shipping Department Expenses .......................... 22,511.32
Depreciation .................................................................. 11,712.10
Facility Costs (rent, taxes, insurance, etc.) ................................ 78,938.15
Advertising and Marketing Costs .......................................... 22,994.91
Fixed Portion of Maintenance (including IT support) ..................... 9,992.98
Fixed Portion of Utilities (including refrigeration) ....................... 10,390.37
Fixed Portion of Office Supplies ............................................. 4,305.66
Fixed Salary of Salespeople ................................................. 32,221.81
Administrative Staff to Assist Owner ...................................... 26,662.83
Total Fixed Costs........................................................... $280,023.28
However, he wants to direct the salespeople to emphasize a certain product when they are out talking to the beer distributors. Given the current machine availability, David is not sure what beer product line to tell the sales people to emphasize in order to maximize his profits.
Finally, David and his family love root beer. Root beer follows a somewhat similar process to beer in that the ingredients are mixed together to form a "culture" that then goes through fermenting, filtering, and filling. Root beer would not need to be aged or stored in the refrigerator. There is an empty area in the current microbrewery facility that could be dedicated to making root beer. As a result, David has been talking with his family about producing and ceiling a line of specialty root beer. Root beer would be produced using different machinery rather than the existing five beer machines. David's sister knows someone who is getting out of the soda business and would be willing to sell the used machinery needed to make the root beer for $8.030. Based on market research he has done, David thinks that he could charge $1630 per case of root beer. Based on the same market research, there is a lot of uncertainty in how many cases of root beer the company could sell. David is less familiar with the root beer market and there is a wide range in sales of specialty root beer in the local groceries. Based on his understanding of the market, he thinks he could sell between 3,000 and 12,000 cases of root beer per annum with likely sales of about 6,000 cases.
Root beer could be sold to some of his current distributors. However, soda does not need to be sold through the three-tier system that is required for alcohol sales. Therefore, much of root beer sales would be directly to upscale groceries such as La Grande Orange Grocery and Pizzeria in Phoenix and Whole Foods and AJ's Fine Foods with locations throughout Arizona. David could produce the root beer in-house or out-source the production. David has talked with another company who could produce the root beer for AMI using David's recipe and AMI could sell it as their brand (this option is referred to as "private label"). It could be purchased from this other company for $13.05 per case. AMI would still need to incur some variable handling costs and some minor fixed costs. Alternatively, AMI could produce the root beer in house. See Exhibit 3 for estimated cost information.
EXHIBIT 3
Root beer Cost Information
Panel A:Alternative 1-Produce In-House
Direct Materials per case ................... $1.75
Direct Labor per case.......................... 2.25
Variable Overhead per case....................3.60
Total Variable Costs per case................ $7.60
Additional Fixed Costs (per year)... $37,640.00
These are recurring costs and do not include the initial purchase cost of the machine.
Panel A:Alternative 1-Produce In-House
Purchase price per case...................... $13.05
Variable Overhead per case.................... 0.10
Total Variable Costs per case............... $13.15
Additional Fixed Costs (per year)...... $6,000.00
Analyzing the sales forecast for root beer, what preliminary course of action do you recommend (in-house or out-source production)? Why? Support your recommendation with breakeven, contribution margin ratio, and operating leverage factor.