Toy World Case

The manufacture of plastic toys was a highly competitive business because of small capital requirement and simple technology. Undoubtedly, design and price competition has become very fierce in the industry and the rate of company failures is relatively high. Due to the nature of the products, market demand for toy remains low in the first half of the year. Subsequently, the number of purchases begins to skyrocket in the second half of the year when holidays starts kicking in. As a result, Toy World has been sticking to its seasonal production schedule for the past years. However, the new production manager, Mr. Hoffman, believes that efficiency and profitability could be improved if the company adopts the level production.

Based on the projected net sales and interest expense for level production, Toy World Inc. would not start to make positive profit until August of 1994. Since the minimum cash requirement for each month is at least $200,000, Mr. Hoffman, the production manager of the company has to start borrowing from the bank in March when the company has collected all the account receivable from previous year. Unable to make any profit in the first 7 months of the year, Toy World Inc. has to increase its borrowings from $116,000 to almost $4 millions before the company starts making positive earnings in August when the net sales increases tenfold compared to previous month, from $160,000 to $1,620,000. Even though the financial statement is jeopardized by this level production, it yields better results than seasonal production. At the end of the year, with the same projected net sales, adopting seasonal production would yield only $351,000 net profit while level production would yield approximately $521,000, a positive $170,000 difference.

As mentioned, despite its tempting profitability, adopting the level production would require a tremendous amount of funds starting in March when the company can no longer remediate its account receivables and the projected net sales cannot offset the operating expense and maintain the required $200,000 to maintain operations. Therefore, the company has to borrow from the banks and the loans keep accumulating to $4,000,000 (see attached file). Not until August when the projected net sales shoot up to $1,620,000 the business becomes profitable.

Given no other choices besides seasonal production and level production, Mr. Hoffman should pursue the level production to optimize the company's profits. Under both production schedule, the company would not make any positive profit until August of 1994, based on the projected net sales. With the seasonal production, the company has a lower operating expense, a monthly $200,000. Yet, combining with overtime wage premiums, the company's expense is substantially larger the expense in level production, an estimated $225,000 in savings.

With the same projected net sales, the company is making more net profit under level

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