Economics Case
What factors could Mr. McClintock consider in deciding whether or not to adopt the level production plan?
In deciding whether or not to adopt the level production plan, Mr. McClintock needs to consider the following factors
Labor Cost – Toy World is projected to save $225,000 in overtime premium and $265,000 in direct labor savings from switching to level production. How easily can it realize these savings? Will there be a cost to creating new procedures and business processes associated with making the switch from seasonal production? Will maintaining the same workforce year-around translate into additional cost in employee benefits?
Increased Leverage – How will the company fund operations during the first 7 months of the year when demand is low and cash from sales will not cover operations cost? Should the company take on the additional $2M line of credit that is secured with the companys inventory and AR? Will this lead to a higher risk of insolvency? Can the company absorb the higher interest charges?
Inventory holding costs – Under level production, inventory will build up in the first seven months of low demand but will progressively be sold off between the months of Aug and Dec. Can the company handle the estimated $115K in additional inventory holding cost? Is there a risk of obsolescence for toys produced too early in the year? Does the company need to build additional warehouses to hold inventory?
Working Capital Fluctuations– A level production plan means raw material purchases will be consistent from month to month. Accounts Payable will thus be predictable throughout the year while Accounts Receivable will fluctuate based on orders fulfilled, in line with historical trends. Can working capital be tightly managed and supplemented by cash infusions in the early months to fund operations?
What savings would be involved? List the components of net savings obtainable from level production.
Following are savings that Toy World can obtain from adopting a level production plan:
Labor Cost Savings – Adopting a level production plan will allow the company to eliminate multiple shift structure and all or most of the overtime premium paid during peak months thus reducing overall labor cost by up to $490,000 (based on historical sales & reduced COGS from 70% to 65.1%).
Recruiting and Training Cost Savings – This cost will be reduced as the workforce can be maintained year around without the need to recruit and train seasonal