Question

Question 15 (20 points) Cars Inc. and Automobile Inc. are two car manufactures. Cars Inc. manufactures high quality cars whereas Automobile Inc. manufactures lower end cars. Cars Inc. is capital intensive You are given the following information about the companies for year millions): more than Automobile Inc. and relies more on fixed assets for its production. X1 (amounts in Cars Inc Automobile Inc Sales S 4376 Sales S 2746 COGS S3785 (68.43%: variable) COGS S2553 (84.76%: variable) The car manufacturing industry expects the following increases in sales in the following years (all compared to the previous year): year X2 2%, year X3 4%, year X4 3%, years 2% a. Comment on the cost structure for both companies and on the likely effect of the cost structure and type of cars manufactured on the price and gross margin of both companies. b. Prepare a forecast of Cars Inc. sales, COGS, gross margin for years X2 to X5 based on the information given above. c. Prepare a forecast of Automobile Inc. sales, COGS, gross margin for years X2 to X5 based on the information given above d. Comment on your results compared to your answer in part a.

Answer 1

a. The cost structure for Cars Inc will have a higher fixed component than the cost structure of Automobile Inc. going forward as well. This is due to the fact that Cars Inc. is a more capital intensive company and hence will have a higher proportion of fixed assets in its total assets compared to Automobile Inc. Being more capital intensive the costs for Cars Inc. will be higher and this will make the company charge a higher price for its cars than Automobile Inc. Gross Margin for Cars will also be higher compared to Automobile Inc. as it will have a higher numerator in the form of sales – cost of goods sold.

b.

CARS INC.	YEARS
	x1	x2	x3	x4	x5
Sales	4,376.00	4,463.52	4,642.06	4,781.32	4,876.95
y-o-y growth (in %)		2.00	4.00	3.00	2.00
COGS	3,785.00	3,860.70	4,015.13	4,135.58	4,218.29
y-o-y growth (in %)		2.00	4.00	3.00	2.00
Variable COGS (68.43% of total COGS)	2,590.08	2,641.88	2,747.55	2,829.98	2,886.58
Fixed COGS (Total COGS - Variable COGS)	1,194.92	1,218.82	1,267.58	1,305.60	1,331.72
Gross margin = Sales - cost of goods sold	591.00	602.82	626.93	645.74	658.66
Gross margin % = gross margin/sales	13.51%	13.51%	13.51%	13.51%	13.51%

For the above computation it has been assumed that total COGS (fixed+variable) will grow at the same rate as the growth rate of sales. It has also been assumed that variable COGS will remain constant at 68.43% of total costs.

c.

Automobile Inc.	YEARS
	x1	x2	x3	x4	x5
Sales	2,746.00	2,800.92	2,912.96	3,000.35	3,060.35
y-o-y growth (in %)		2.00	4.00	3.00	2.00
COGS	2,553.00	2,604.06	2,708.22	2,789.47	2,845.26
y-o-y growth (in %)		2.00	4.00	3.00	2.00
Variable COGS (84.76% of total COGS)	2,163.92	2,207.20	2,295.49	2,364.35	2,411.64
Fixed COGS (Total COGS - Variable COGS)	389.08	396.86	412.73	425.12	433.62
Gross margin = Sales - cost of goods sold	193.00	196.86	204.73	210.88	215.09
Gross margin % = gross margin/sales	7.03%	7.03%	7.03%	7.03%	7.03%

d. As we can see from the tables provided in part “b” and “c” of my answers the fixed COGS of Cars Inc. remains substantially higher than fixed COGS of Automobile Inc. for the entire duration of year x1 to year x5. Also as stated in part “a” we can see that Car’s gross margin percentage is much higher (13.51%) than Automobile’s gross margin of 7.03%.