Question

The Bonwire Kente Company Case

Your friend, Kwame Nkrumah from Ghana knows that you are taking graduate classes and asks for your opinion on an issue he faces as owner/manager of the Bonwire Kente Company which he started 5 years ago with 20 employees. The Company has grown by leaps and bounds to the point where it now employs over five hundred persons and has become a nightmare to manage.

The Company weaves the cotton it grows on its 4,000- acre farm into Kente cloth, which it dyes and sells both locally and abroad. The process from farm to market is complex and varied. At present he has identified the following five major phases:

Phase I - Planting, growing, reaping, transporting, storing the cotton employs three hundred (300) persons

Phase II - Dyeing and weaving process employs one hundred (100) persons

Phase III - Quality control employs twenty (20) persons

Phase IV - Marketing and Sales employs seventy (75) persons

Phase V – Distribution employs forty (40) persons

Phase VI – Administration, Accounting, Collection and Cash Management employs thirty (30) persons

The major issue he faces is managing growth for maximum profitability and reduced costs.

Required:

Part A

From what you have learned about agency costs and responsibility centers, write a detailed letter to Kwame explaining how he might organize his company. Assume that he knows nothing about responsibility centers and agency costs and make your recommendations applicable to the Bonwire Kente Company.

Part B

Kwame has also told you that his Accounting Department gave him the following data for the last year’s (2019) operations:

Description	Local Market	Foreign Market
Kente Fabric Sold (yards)	2,500,000	1,800,000
Selling price per yard	$30	$50
Variable cost per yard	$10	$16
Fixed costs	$5,000,000	$7,000,000
Desired annual profit after taxes	$6,000,000	$10,000,000
Tax rate	15%	20%

Being an agricultural professional by training, he is unfamiliar with concepts like breakeven analysis and profitability planning. He trusts his accountant but wants you to verify the numbers they have placed on his desk. He asks you to calculate for him:

1. The yards of Kente fabic he must sell in each market to breakeven
2. The revenues the company must generate to breakeven in each market
3. The yards of Kente fabric the company must sell to achieve the desired profit in each market
4. The revenues the company must generate to achieve the desired profit in each market
5. The implications that the results you have calculated in (c) above have on his production of cotton if it takes 100 pounds of cotton to make one yard of Kente fabric.

Part C

Finally, Kwame has told you that he is facing an investment decision that involves purchasing a weaving machine that the engineers have told him would increase efficiency and productivity. If he decides to purchase the Weaver Pro, he can trade in the current Weaver I for $150,000. The data collected about the Weaver Pro follows.

Price                                               $1,000,000

Productive Life                              7 years

Pretax cash flows:

      Year 1                                           $ 250,000

      Year 2                                              350,000

      Year 3                                              500,000

     Year 4                                              800,000

      Year 5                                              800,000

    Year 6                                              800,000

     Year 7                                                750,000

Salvage value at the end of year 7, $100,000.

The company’s average tax rate is 15% and its average cost of capital is 10%.

Advise Kwame whether it would be a good decision to purchase the Weaver Pro with supporting arguments.

Answer 1

Breakeven units: fixed cost/ (revenue per unit-cost per unit)

=> 7,000,000/(50-16) ====> 205882 units

Breakeven revenue: fixed cost/ contribution margin

=> Contribution margin= (sales-variable cost)/sales

Cm= (50-16)/50=68%

So, 7,000,000/(0.68)= 10,294,117.64

3. let the no of yarns be x

Desired profit = 10,000,000= 50x-16x-7,000,000

=>3,000000=34x

X i.e units sold=> 88,235.29 units

4. Revenue= desidred units ie. 88235.29* sales ie. 50

-----> $4411764.5