Toy World, Inc. is a fairly healthy toy manufacturing business that is looking at a cross roads in it's main operating procedure. Jack McClintock is President and partial owner of Toy World. His new production manager, Dan Hoffman, has been on the job through one business cycle (about one year). This toy business is a seasonal business with most of the sales coming between August and December. Since its inception Toy World has followed a seasonal production schedule to match customer demand.
After Hoffman's short time one the job he has become concerned with Toy World's method of scheduling production. He has urged McClintock to change methods to a level production schedule (same amount of production hours each month). Hoffman's main arguments are that Toy World could save money at about $225k from overtime premiums during peak production times as well as an additional $265k from a more orderly production process. Hoffman has also conceded that part of the savings would be offset by about $115k in additional storage and handling costs. Another important factor in Hoffman's case is that Toy World will approach full capacity during 1994's peak season production. Due to recent expansions Toy World has a strained working capital position and would most likely have trouble affording another expansion in the near future. McClintock knows that Hoffman may be onto something but there is more to this decision than meets the eyes.
With a first look at the financials and Hoffman's case to move to level production schedules it seems to be a no-brainer for Toy World. Looking at exhibit 4 the income statement for a level production type in 1994 shows a Net Profit of $538k; a difference of $187k (exhibit 5). This increase is powered by the $490k savings from reduced overtime and orderly production. The favorability is partially offset by the extra $115k in storage, $93k in extra interest, and an additional $95k in marginal tax. If the Net Profit is put...
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