Reference no: EM133208264

Case

The excitement in the car was palpable as Micah and her roommate inched closer toward campus for their final semester at Penn State University. They had left Micah's parents' house in Philadelphia a couple of hours prior, and even the bitterly cold, grey January day could not dampen the senior business management major's spirits. But it was not just the prospect of seeing friends once again that was stoking her eagerness to get to Happy Valley. Micah had an idea. When Micah arrived at her apartment, she unlocked the door and dropped her bags inside. Much to her roommate's surprise, she ran right back out the door and downstairs to the mail room where an Amazon box with her name on it had been waiting for her. The box contained an electric griddle that she had ordered a couple of days prior and paid for with USD 100 received from her grandmother over the holidays, which she would use toward the business as start-up capital. She had also "borrowed" a spatula and butter knife from her parents' kitchen that she was sure they would not miss. She had her overhead in place, and she wanted to get open for business as soon as possible. Micah had the idea to open a pop-up grilled cheese shop in her apartment at the end of finals week last semester. After being out on the town with friends celebrating the end of the term late into the evening, they came back to Micah's apartment, where she made all of them grilled cheese sandwiches. A few of her neighbors heard them talking as they walked down the hall returning from their nights out, and when they poked their heads in, she made them sandwiches too. One friend commented that she wished Micah would make her a grilled cheese sandwich at the end of the night every time they went out, and a light bulb went off in Micah's head.

Micah had taken an entrepreneurship class in the fall as an elective, so she had learned the concept of a minimum viable product (MVP) and testing it on your target customers when starting a business. As she left college the next day to go back home for the winter break, she knew that last night's smorgasbord was a validation of that MVP. By the time she hit the Schuylkill Expressway, her mind was made up and she began working on her late-night grilled cheese shop that would be run out of her apartment during her final semester in college.

On the ride back to campus, Micah discussed the idea with her roommate. After all, if her best friend and the person she lived with did not want people coming into their apartment late at night, then this idea was dead in the water. However, much to Micah's delight, her roommate approved of the idea, but not without some contingencies:

• She could only be open for business on Thursday, Friday, and Saturday nights, and hours would be from 10 p.m. to 3 a.m.

• Customers had to take the sandwiches "to-go"; no sitting and eating in the apartment (unless of course they were a close friend).

• Micah had to pay USD 10 per month extra for the electric costs from the griddle and would be responsible for all cleaning needs resulting from her inebriated customers.

The next few days passed as Micah prepared for the start of the semester and classes began. By the time Thursday morning came around, she was excited to go from her final class of the week straight to the downtown market to purchase the ingredients on her way home. She purchased a loaf of bread, a pack of cheese, a tub of butter, and a roll of aluminum foil. In her planning, she determined that each sandwich would use two slices of bread, one slice of cheese, 1 oz. of butter, and 1 sq. ft of foil. Earlier in the week, she had paid USD 10 to run an ad on social media promoting her hours and giving her address. Table 1 gives a breakdown of each of her overhead costs and raw materials as well as corresponding start-up costs going into her first weekend of business.

Table 1. Grilled Cheese Business Cost Breakdown

Item Cost (USD)      Description

Electric griddle        29.90 + tax On sale on Amazon; free shipping due to Prime membership

Butter knife and spatula "FREE" Stolen from parents' kitchen over break

Utilities               10/mo. Roommate stating that griddle will drive up the electric bill

Advertising      10 Marketing and promotion

Bread     1.99/loaf 20 slices per loaf including heels

Cheese    3.69 24 slices in a pack

Butter       4.99 67.5 oz. tub

Aluminum Foil     3.98 + tax 75 sq. ft roll

Note: Pennsylvania sales tax = 6%. Sales tax is not collected on unprepared food. Micah got back to her apartment and immediately started preparing for her grand opening by cutting the foil into 1 sq. ft pieces. She made a test run on the griddle the weekend before with her roommate and another friend, to rave reviews. She took a nap after lunch, knowing it would be a late night and feeling good that all the pieces were in place for her to start her first venture with this cash-only business.

Definitions and Formulas

(adapted from Neck et al., 2018)

Cost of goods sold (COGS): the value of goods sold when a sale takes place (i.e., raw materials and packaging) (excluding labor, overheads, utilities, etc.)

Margin (aka, gross margin): the difference between revenue and the associated COGS

Margin = sales revenue - COGS Example: If a product sells for USD 100 and costs USD 70 to manufacture, the margin is USD 30. Stated as a percentage (as it often is), the margin would be 30%.

Markup: the amount by which the cost of a product is increased in order to derive the selling price.

Markup = price - COGS

Example: For the same product above, the markup is USD 30. As a percentage, it is 42.9% (= Markup / COGS)

Break-even Analysis

Break-even point: when total revenues are equal to total costs. The break-even point in units is the number of units that need to be sold to cover all costs, both fixed and variable.

Break-even point (in units) = Fixed costs / Sales price per unit - Variable cost per unit

Fixed costs: costs that remain constant over the entire range of output. These costs typically include rent, insurance, interest charges, executive salaries, etc.

Variable costs: costs that vary directly with the sales level: manufacturing labour, materials used in production, sales costs, etc.

Break-even analysis:

• Determines sales volume necessary for a business to break even.

• Above break-even, business is making money.

• Below break-even, the business is losing money.

• The ability to control costs accurately can be enhanced by forecasts of the effect of the break-even point.

Break-even Example

If the company's fixed costs are estimated at USD 50,000 and variable costs of USD 0.20/unit with a USD 1 price/unit, the break-even point would be 62,500 units.

50,000 / (1.00 - 0.20) = 62,500 units

What would happen if the price increased to USD 2 with the same variable cost per unit?

50,000 / (2.00 - 0.20) = 27,778 units

It is most desirable for projected sales to be larger than break-even sales to avoid losses. You should not assume a sales volume and then determine profits, but rather do the opposite.

Question 1

What is the cost of goods sold (COGS) for Micah to produce one sandwich?

Question 2

What is the markup if Micah charges USD 1 per sandwich?

Question 3

Taking all costs listed into account, how many sandwiches would Micah need to sell to break even?

Question 4

What issues could you see arising for Micah at this point?

Question 5

Which of the identified costs above are fixed costs? Variable costs?