Play Time Toy Company1

Play Time Toy faces a highly seasonal pattern of sales. In the past, Play Time has used a seasonal production schedule, where the amount produced each month matches the sales for that month. Under this production plan, inventory is maintained at a constant level. The production manager, Thomas Lindop, is proposing a switch to a level, or constant, production schedule. This schedule would result in significant savings in production costs but would have higher storage and handling costs, fluctuating levels of inventories, and would also have implications for financing. Jonathan King, president of Play Time Toy, has been reviewing pro forma income statements, cash budgets, and balance sheets for the coming year under the two production scenarios. Table 1 shows the pro forma analysis under seasonal production, and Table 2 shows the pro forma analysis under level production. Greg Cole, chief financial officer of Play Time, prepared the two tables. He explained that the pro forma analyses in Tables 1 and 2 take fully into account the 11% interest payments on the unsecured loan from Bay Trust Company and the 3% interest received from its cash account. An interest charge of 11%/12 on the balance of the loan at the end of a month must be paid the next month. Similarly, an interest payment of 3%/12 on the cash balance at the end of a month is received in the next month. The inventory available at the end of December 1990 is $530,000 (measured in terms of cost to produce). Mr. Cole assumed that this inventory represents a sales value of $530,000/0.651667 = $813,300. The inventory and overtime costs in Tables 1 and 2 are based on the cost information developed by Mr. Lindop. This information is summarized in Table 3. Mr. Cole further explained how the cost information was used in the pro forma analyses. For example, in Table 1, the production in August is $1,458,000. The overtime cost in August is therefore calculated to be $61,000 (=0.15 x (1,458,000 -1,049,000)). Play Time uses LIFO (last-in, first-out) accounting, so overtime costs are always charged in
From Practical Management Science (2nd ed., Winston and Albright, 2001 Duxbury Press, p. 490-492; Case 9.1).
1

the month that they occur.2 The annual overtime cost for the seasonal production plan is $435,000. In Table 2, under level production, finished goods worth $5,164,000 are in inventory at the end of July. The inventory cost for the month is $20,000 (=0.07/12 x (5,164,000 - 1,663,000)). The annual inventory cost for the level production plan is $100,000. Mr. Lindop felt that a minimum of $813,300 of inventory (measured in terms of sales value, or $530,000 measured in terms of cost to produce) must be kept on hand at the end of each month. This inventory level represents a reasonable safety stock, required since orders do not occur uniformly during a month. Mr. King was impressed at the possible increase in profit from $237,000 under the seasonal production plan to $373,000 under level production. While studying the pro forma projections, Mr. King realized that some combination of the two production plans might be even better. He asked Mr. Lindop to try to find a production plan with a higher profit than the seasonal and level plans. Mr. Lindop proceeded to develop a spreadsheet-based linear programming model to maximize annual net profit.

Questions
Note: Mr. Lindop's model is contained in the file playtime.xls. The spreadsheet is ready to be optimized, but it has not been optimized yet. 1. Run the optimization model in the file playtime.xls. What is the optimal production plan? What is the optimal annual net profit? How does this optimal production plan compare to the seasonal and level production plans? 2. Suppose that Play Time's bankers will not extend any credit over $1.9 million in other words, the loan balance in any month cannot exceed $1.9 million. Modify the spreadsheet model to take into account this restriction. What is the optimal production plan in this case? What is the optimal annual net profit? 3. Annual profit is a measure of reward for Play Time Toy. The maximum loan balance is a measure of risk for the bank. Construct a trade-off curve between optimal annual profit and the maximum loan balance.

This assumes that overtime production is used only to satisfy current demand and not to build up inventory. 2 Prof. Juran

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Table 1: Seasonal Production (Annual net profit = 237)

Actual Dec 1990 850 813 Jan 108 813 Jan 108 70 0 38 188 0 (150) 10 (160) (55) (106) Actual Dec 1990 175 2,628 530 1,070 4,403 255 680 80 450 2,938 Feb 126 813 Feb 126 82 0 44 188 0 (144) 2 (146) (50) (97) Mar 145 813 Mar 145 94 0 51 188 0 (137) 1 (138) (47) (91) Apr 125 813 Apr 125 81 0 44 188 0 (144) 1 (146) (50) (96) May 125 813 May 125 81 0 44 188 0 (144) 2 (146) (50) (97) Projected for 1991 June July Aug 125 813 June 125 81 0 44 188 0 (144) 2 (147) (50) (97) 145 813 July 145 94 0 51 188 0 (137 ) 2 (140 ) (48) (92) 1,45 8 813 Aug 1,45 8 950 61 447 188 0 259 3 256 87 169 Sept 1,65 5 813 Sept 1,65 5 1,07 9 91 486 188 0 298 7 290 99 192 Oct 1,92 5 813 Oct 1,92 5 1.25 4 131 539 188 0 351 18 333 113 220 Nov 2,05 7 813 Nov 2,05 7 1,34 0 151 565 188 0 377 19 359 122 237 Dec 1,00 6 813 Dec 1,00 6 656 0 350 188 0 162 19 144 49 95 Total 9,000 Total 9,000 5,865 435 2,700 2.256 0 444 86 358 122 237

Production (sales value) Inventory (sales value) INCOME STATEMENT Net sales Cost of goods sold Materials & regular wages Overtime wages Gross profit Operating expenses Inventory cost Profit before int & taxes Net interest payments Profit before taxes Taxes Net profit

BALANCE SHEET Cash Accts receivable Inventory Net P/E Total Assets Accts payable Notes payable Accrued taxes Long term debt Equity

Jan 782 958 530 1,070 3,340 32 0 25 450 2.832

Feb 1,365 234 530 1,070 3,199 38 0 (24) 450 2,736

Mar 1,116 271 530 1,070 2,987 44 0 (151) 450 2,644

Apr 934 270 530 1,070 2,804 38 0 (232) 450 2,548

May 808 250 530 1,070 2,658 38 0 (282) 450 2,452

Projected for 1991 June July Aug 604 250 530 1,070 2,454 38 0 (363) 425 2,355 450 270 530 1,070 2,320 44 0 (411) 425 2,263 175 1,603 530 1,070 3,378 437 408 (324) 425 2,431

Sept 175 3,113 530 1.070 4,888 497 1,600 (256) 425 2,623

Oct 175 3,580 530 1,070 5,355 578 1,653 (143) 425 2,843

Nov 175 3,982 530 1,070 5,757 617 1,656 (21) 425 3,080

Dec 175 3,063 530 1,070 4,838 302 966 (4) 400 3,175

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Prof. Juran

Total liab & equity

4,403

3,340

3,199

2,987

2,804

2,658

2,454

2,320

3,378

4,888

5,355

5,757

4,838

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Prof. Juran

Table 2: Level Production (Annual net profit = 373)

Actual Dec 1990 850 813 Jan 750 1,45 5 Jan 108 70 0 38 188 0 (150 1 10 (160 ) (55) (106 ) Feb 750 2,07 9 Feb 126 82 0 44 188 2 (147) 3 (149) (51) (99) Mar 750 2,68 4 Mar 145 94 0 51 188 6 (143) 2 (146) (50) (96) Apr 750 3,30 9 Apr 125 81 0 44 188 10 (154) 5 (159) (54) (105) May 750 3,93 4 May 125 81 0 44 188 13 (158) 10 (168) (57) (111) Projected for 1991 June July Aug 750 4,55 9 June 125 81 0 44 188 17 (161) 15 (177) (60) (117) 750 5,16 4 July 145 94 0 51 188 20 (158) 21 (179) (61) (118) 750 4,45 6 Aug 1,45 8 950 0 508 188 16 304 26 277 94 183 Sept 750 3,55 1 Sept 1,65 5 1,07 9 0 576 188 11 377 32 346 118 228 Oct 750 2,37 6 Oct 1,92 5 1,25 4 0 671 188 4 478 37 441 150 291 Nov 750 1,06 9 Nov 2,05 7 1,34 0 0 717 188 0 529 31 498 169 329 Dec 750 813 Dec 1,00 6 656 0 350 188 0 162 22 141 48 93 Total 9,00 0 5,86 5 0 3,13 5 2,25 6 100 779 214 565 192 373 Total 9000

Production (sales value) Inventory (sales value) INCOME STATEMENT Net sales Cost of goods sold Materials & regular wages Overtime wages Gross profit Operating expenses Inventory cost Profit before int & taxes Net interest payments Profit before taxes Taxes Net profit

BALANCE SHEET Cash Accts receivable Inventory Net P/E Total Assets Accts payable

Actual Dec 1990 175 2,628 530 1,070 4,403 255

Jan 556 958 948 1,070 3,533 225

Feb 724 234 1,355 1,070 3,383 225

Mar 175 271 1,749 1,070 3,265 225

Apr 175 270 2,157 1,070 3,672 225

May 175 250 2,564 1,070 4,059 225

Projected for 1991 June July 175 250 2,971 1,070 4,466 225 175 270 3,365 1,070 4,880 225

Aug 175 1,603 2,904 1,070 5,752 225

Sept 175 3,113 2.314 1,070 6,672 225

Oct 175 3,580 1,549 1,070 6,374 225

Nov 175 3,982 697 1,070 5,924 225

Dec 175 3.063 530 1,070 4,838 225

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Prof. Juran

Notes payable Accrued taxes Long term debt Equity Total liab & equity

680 80 450 2,938 4,403

0 25 450 2,832 3,533

0 (25) 450 2,734 3,383

108 (155) 450 2,637 3,265

704 (240) 450 2,533 3,672

1,259 (297) 450 2,422 4,059

1,900 (389) 425 2,305 4,466

2,493 (450) 425 2,187 4,880

3,087 (355) 425 2,370 5,752

3,693 (269) 425 2,599 6,672

2,953 (119) 425 2,890 6,374

2,005 50 425 3,218 5,924

836 66 400 3,311 4,838

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Prof. Juran

Play Time Cost Information

Gross margin. The Cost of goods sold (excluding overtime costs) is 65.1667% of sales under any production schedule. Materials costs are 30% of sales. All other non-materials costs, including regular wages but excluding overtime wages, are 35.1667% of sales. Overtime cost. Running at capacity but without using any overtime, the plant can produce $1,049,000 of monthly sales. Units produced in excess of this capacity in a month incur an additional overtime cost of 15% of sales. (The monthly production capacity of the plant running on full overtime is $2,400,000 of sales. Since November has the maximum level of projected sales at $2.057.000, the capacity on full overtime should never pose a problem.) Inventory cost. The plant has a limited capacity to store finished goods. It can store $1,663,000 worth of sales at the plant. Additional units must be moved and stored in rented warehouse space. The cost of storage, handling, and insurance of finished goods over this capacity is 7% of the sales value of the goods per year, or 7%/12 per month.

B60.2350

Prof. Juran