Question

Miller Orchard Case -

Paul and John Miller have just been presented with an offer from their uncle.  Uncle Joe can no longer manage his orange orchard, which produces orange juice that is bought by local restaurants and diners to serve their customers; he has offered to turn it over to his nephews to manage as they like if they can provide him a small annual return (10% of sales revenue) to supplement his retirement.  Paul and John have grown up with the orchard and worked there all through their childhood, so they know the business well and love the work.  They are very excited by this prospect.

Miller Orchard typically yields about 1,200,000 pounds of oranges a season. Oranges are cultivated and harvested when ripe; then the juice is extracted.  The remaining pulp and rind are recycled back onto the fields whenever possible or disposed of. Paul and John know that the amount of oranges available for harvest and the amount of juice generated from the oranges is variable, however, dependent each year on a number of climatic and growing factors such as temperature, length of growing season, and fertilizers used. Every year so far, Miller Orchard has sold all the orange juice that it has produced.  The current selling price is $5 per bottle.

Uncle Joe presents the brothers with an Income Statement that he has had prepared for last year (see Exhibit 1).  He provides the following additional information:

Bottling

• Requires 12 pounds of oranges for each bottle of juice.
• In the bottling process, the juice is put into bottles, with both bottle caps and labels added during this process. The materials cost associated with the bottles, caps, and labels averages $1.25/bottle.

Direct labor

• Harvest labor is paid an average of $9.00/hour. An average of 300 pounds of oranges can be harvested each hour.
• Extraction labor is paid an average of $11.00/hour. The extraction process can be completed for 600 pounds of oranges each hour.

Overhead expenses

• Supervisor salary -- supervises the production from the cultivation and harvest through the bottling processes. His salary and benefits total $80,000 annually.
• Sales salary – a sales person receives salary and benefits of $60,000, plus $.50/bottle for each bottle sold.
• Packing/shipping labor – workers pack 100 bottles per hour for shipment and are paid an average of $10.00/hour.
• Waste treatment – After crushing, the pulp, seeds, and rind that are left over must be disposed of. One-half of the waste can be recycled back onto the fields as a compost material; the other half must be disposed of at a landfill with a dumping cost of $2,000.

Paul and John figure that if they can each earn salary and benefits of about $90,000 to start, they can support their families and start to develop a promising business. They plan to work the orchard themselves, eliminating the cost of the supervisor and sales manager (although they would probably need to pay distributors the $.50 for each bottle sold).  They anticipate that the remaining costs will be unchanged.

Required:

Based on Uncle Joe’s results from last year, determine which costs are variable and which are fixed, and then develop a contribution margin analysis for the venture.  What is the contribution per bottle of juice?

1. What is the contribution margin with the changes that Paul and John want to make, assuming that production and sales remain the same?  What is the number of bottles of orange juice that they would need to sell to break even?
2. If Paul and John find that they need to increase their own salary/benefit packages to $110,000, how many bottles would they need to sell?  Is this feasible?
3. Should Paul and John investigate further before starting into this venture?  What other factors might impact the success of their business?  Should they accept?

Exhibit 1

Miller Orchard

Income Statement

For the Year Ended 12/31/15

Revenues		$500,000
Product costs
Harvest labor	36,000
Extraction labor	22,000
Bottles, labels, caps	125,000
Utilities	4,500
Waste treatment	2,000
Supervisor	80,000
Total product costs		269,500
Gross margin		230,500
Administrative & sales costs
Sales manager	$60,000
Sales commissions	50,000
Office supplies	10,000
Packing/shipping labor	10,000
Packing/shipping supplies	10,000
Total administrative & sales costs		140,000
Net operating profit		$  90,500

Answer 1

Particular	Costs	Variable/fix	Reason
Product costs
Harvest labor	36,000.00	Variable	Directly attributed to product volume
Extraction labor	22,000.00	Variable	Directly attributed to product volume
Bottles, labels, caps	125,000.00	Variable	Directly attributed to product volume
Utilities	4,500.00	Variable	Directly attributed to product volume
Waste treatment	2,000.00	Fix	Not related directly to volume
Supervisor	80,000.00	Fix	Related to time
Sales manager	60,000.00	Fix	Related to time
Sales commissions	50,000.00	variable	Directly attributed to product volume
Office supplies	10,000.00	Variable	Assumed in absence of any information
Packing/shipping labor	10,000.00	Variable	Directly attributed to product volume
Packing/shipping supplies	10,000.00	Variable	Directly attributed to product volume
Sales	500,000.00
Less:variable costs
Harvest labor	36,000.00		Total sales	500000
Extraction labor	22,000.00		S.P per bottle	5
Bottles, labels, caps	125,000.00
Utilities	4,500.00		No of bottles	100000
Sales commissions	50,000.00
Office supplies	10,000.00
Packing/shipping labor	10,000.00
Packing/shipping supplies	10,000.00
Present Contribution	232,500.00
no of bottles	100,000.00
Contibution per bottle	2.33
Present Contribution	232,500.00
			Calculation of Fix cost
Savings:			Waste treatment	2,000.00
sales manager salary	Nil	as it is fixed	Supervisor	Nil
supervisor manager salary	Nil	as it is fixed	Sales manager	Nil
sales commission	50000
Additional variable costs:			Total	2,000.00
10% of sales to uncle	-50000	500000*10%
distributors expenses	-50000	100000*0.5
Revised contribution	182,500.00
no of bottles	100000
Revised contribution per bottle	1.83
Calculating BEP
Sales units* contribution per unit= Revised fix cost
Units*1.83=2000
Units	1093	2000/1.83
Desired Profit	220000	110000*2
Revised fix cost	2,000.00
Desired contribution	222000
Contribution per unit	1.83
No of bottles to be sold	121,645.00	222000/1.83
Pounds required	1,459,740.00	121645*12
Available quantity	1,200,000
Not feasible as available quantity<desired quantity
Factors to be considerd
Certainity of all assumptions
uncertainity of all output to be produced and sold