Company Background

Plastic Toy Inc. was founded in 1973 by Early in January 1994 Mr. Abdullah, president and part owner of Plastic Toy Inc. was considering a proposal to adopt level monthly production for the coming year. In the past, the company's production schedules had always been highly seasonal reflecting the seasonality of sales. Mr. Abdullah was aware that marked improvement in production efficiency could result from level production, but he was uncertain what the impact on other phases of the business might be (Trade-Off).

Plastic Toy Inc. was the manufacturer of plastic toys for children. It’s product groups included toy cars, trucks, construction equipment, spaceships, musical instruments, animals, robots and action figures. In most of the product categories the company produced a wide range of designs colors and sizes. Dollar sales of a particular product sometimes varied by 40 to 50% from one year to the next. The manufacture of plastic toys was a highly competitive business (Features of Pure Competition) and the industry was populated by a large number of companies many of which were short on capital and management talent. Since capital requirements were not large and the technology was a relatively simple it was easy for new competitors to enter the industry. On the other-hand design and price competition was fierce, resulting in short product life cycles and a high rate of company failures.   A company was sometimes able to steal a march on the competition by designing a popular toy often of the fad variety. Such items commanded high margins until competitors were able to offer similar products. For example, Plastic Toy Inc.’s introduction of a line of superhero action figures in 1991 had contributed significantly to that year’s profit. In 1992 however, 11 competitors marketed similar products and the factory price of Plastic Toy Inc. offering plummeted. In recent years competitive pressures on smaller firms had also intensified due to influx of imported toys produced by foreign toy manufacturers who had much lower labor costs.

Company Background

Plastic Toy Inc. was founded in 1973 by Mr. Abdullah after his retirement from the armed services. Before his military service he had been employed as a production manager by a large manufacture of plastic toys. Mr. Abdullah and his former assistant Mr. Zubair established the company with their savings in 1973.

Originally a partnership, the firm was incorporated in 1974, with Mr. Abdullah taking 75% of the capital stock and Mr. Zubair taking 25%. The latter served as production manager and Mr. Abdullah as President was responsible for overall direction of the company’s affairs. After a series of illnesses Mr. Abdullah decided to retire from the business in 1991 Mr. Zubair assumed the presidency at that time. In 1993 Mr. Zubair hired Mr. Faisal a recent graduate of a prominent technical institute as production manager. Mr. Faisal had worked during the summers in the plastics plant of the large diversified chemical company and thus had a basic familiarity with plastics production processes

Company Growth

The company had experienced relatively rapid growth since its founding and enjoyed profitable operations each year since 1976. Sales had been approximately $9 million in 1993 and based on the on the changing economic conditions projections for sales and profitability under seasonal production are as given in Table A. Tables A & B present the latest financial statements for the company. Cost of goods sold averaged 70% of sales in the past and was expected to maintain roughly that proportion in 1994 under seasonal production. In keeping with the companies experience operating expenses will likely to be incurred evenly throughout each month of 1994 under either seasonal or level production. Expanding operations had resulted in a somewhat strained working capital position of the company, the year-end cash balance of $100,000 in 1993 was regarded as the minimum necessary for the operations of the business. (No company can operate with zero cash, each co. has a min. cash in hand requirement)

The company had borrowed in the past from their main bank Al-Falah trust Inc. on an unsecured line of credit against which $400,000 was outstanding at the end of 1993. Mr. Zubair had been assured that the bank would be willing to increase this line of credit of up-to $1.0 million in 1994 with the understanding that the loan will be completely repaid and will be off-the-books for least a 30 day period during the year and would be secured by lien on accounts receivable and inventory of the company. Interest on the line of credit would continue to be charged @ 7% p.a., but if the amount borrowed exceeded $1million the bank would charge 32/5% penal interest on the excess amount borrowed over the agreed credit line The company’s long-term debt which had been raised years ago had a fixed interest rate of 95/8 % p.a. and was being amortized through payments of 25,000 in June and December each year. The company’s sales were highly seasonal, over 80% of the annual dollar volume was usually sold between August and November. Table B shows monthly projected sales for 1994. Sales were mainly made to large store chains and brokers. Although the company quoted credit terms of net 30 days most customers took 60 days to pay however the collection experience was excellent
The company's production process was not complex. Plastic molding powder the main raw material was processed by injection molding presses and formed into the shapes desired. The toy sets were then assembled and packaged in cardboard cartons. Typically, all production runs begun work completed on the same day so that there was virtually no work-in-process at the end of the day.

Purchases on net 30-day terms were made weekly in amounts necessary for the estimated production in the coming week. Total purchases for 1994 are shown in Table A under seasonal production. It was the company's policy to retire trade debt promptly as it became due. Mr. Faisal believed the company would be able to hold capital expenditures during the next year to an amount equal to depreciation although he had cautioned that projected volumes of 1994 would approach full capacity of the companies equipment. It was the company’s practice to produce in response to customer orders. This meant that only a small fraction of the capacity was needed to meet demand for the first seven months of the year thus not more than 25 to 30% of manufacturing capacity was used at any one time doing this period. The first sizable orders arrived around the middle of August to December. During this time the workforce was greatly expanded and put on overtime and all equipment was used 16 hours a day. In 1993 overtime premiums have amounted to $185,000. Whenever possible shipments were made on the day an order was produced. Hence production and sales amounts in each month tended to be equal. As in the past, the pro forma income statement based on an assumption of seasonal production had been prepared for 1994 and presented to Mr. Abdullah for his examination. 

Proposed Changes to Level Production

Having experience of one selling season at the company Mr. Faisal was not happy with the many problems that arose from the company’s method of scheduling production. Overtime premiums reduced profits, seasonal expansion and contraction of the workforce resulted in recruiting difficulties and high training and quality control costs. Machinery stood virtually idle for 7½ months and then was subjected to heavy use. Accelerated production schedules during the peak season resulted in frequent setup changes on the machinery. A seemingly unavoidable confusion in scheduling runs resulted.

For the above reasons Mr. Faisal suggested to Mr. Abdullah to adopt a policy of level monthly production in 1994. He pointed out that estimates of sales volume had usually proved to be reliable in the past, purchasing terms would not be affected by the rescheduling of purchases. The elimination of overtime wage premiums would result in savings estimated at $70,000 in 1994 moreover Mr. Faisal firmly believed that additional direct labor savings amounting to $88,000 would result from orderly production, however a portion of the savings would be offset by higher storage and handling costs estimated at $75,000 annually. Mr. Abdullah speculated on the effect that level production might have on the companies Funds Requirements and Net Income in 1994. To simplify the problem Mr. Abdullah assumed that Cost of Goods Sold would by 70% under seasonal production and 65 % under level production method.

Answer rating: 100% (QA)

ANSWER 1The effect of level production on funds requirements and net income Level production would have a positive effect on the companys funds requir... View the full answer