1

CASE STUDY
Mead Meals on Wheels Center

Input
Average Fixed Cost per week 36,000 $
Revenue per client week 32.00 $
Maximum Clients per week 4,800
number of weeks in a quarter 13
Difference between bid abd break even 0.50 $
Budgeted per client weekly food costs 24.00 $
Actual Meals Delivered 1st Quarter 4,600
Unit Cost Difference in 1st Quarter 0.75 $
Actual Cost in 1st Quarter 23.25 $
Additional fixed weekly costs in 1st Quarter 2,000 $
Cost of Additional Kitchen Equipment 700,000 $
Cost of Capital 9%
Interest Rate on Loan 8%
Life of Equipment in years 5
Maximum number under the contract 5,200
Assumed Residual Value 10%
Quarter1 Quarter 2 Quarter 3 Quarter 4
Quarterly Fixed Costs per week 38,000 $ 34,000 $ 35,000 $ 37,000 $


Question 1 is a variation of the break-even problem from Chapter 4. It asks you to calculate the
maximum amount that MMWC can spend per person per week on food. In other words, what is the
largest variable cost that MMWC can afford to pay and still cover all of its fixed costs.

From the case you know that the Unit Revenue is $32 per week. To earn that amount, MMWC
must feed one person 2 meals per day for seven days or 14 total meals per week. Let's call that the
number of contract meals. We know that MMWC's daily capacity is 9,600 meals per day. since the
contract calls for feeding each person two meals per day, the means MMWC can feed 4,800 people per
day (Q). (9,600 meals / 2 meals per person per day). It turns out that is also the number of people they can
feed each week. Here is why:

weekly capacity in meals 9,600 meals x 7 days
People fed per week = --------------------------------------- = ------------------------------
contract meals per person fed 2 meals per day x 7 days


= 4,800 people fed per week @ $ 32 per person






2

To find the formula for how much MMWC can spend per week per person on food, we need to
do a little algebra. The base break-even formula is:

Fixed Cost (FC)
Break-even Quantity (Q) = -----------------------------------------------------
Unit revenue (P) - Unit Variable Cost (VC)

Where: Q = 4,800 people fed per week
P = $32 per person fed for a week
FC = $36,000 per week

FC
Q = ---------------
P - VC

multiplying both sides of the equation by P - VC we get:

Q x (P - VC) = FC

expanding the term on the left side we get:

Q x P - Q x VC = FC

Subtracting Q x P from both sides we get:

-Q x VC = FC - Q x P

Multiplying both sides by -1 we get:

Q x VC = Q x P - FC

Dividing both sides by Q we get the formula for the Break-Even Variable Cost:

Q x P - FC
VC = -------------------
Q

Substituting the values above, we find that the Break-Even Variable Cost is:

4,800 x $32 - $36,000
VC = ------------------------------- = $24.50
4,800

$24.50 per person per week is the maximum amount that MMWC can spend for food.

If you think about this equation, it makes sense. The numerator says that you can only spend what
you have left after paying your fixed costs on food. That is total revenue less fixed costs or $117,600 per
week. Dividing that number by the maximum number of people MMWC can feed (the denominator -
4,800) gives you the average cost per person fed. That is also the maximum MMWC can spend since FC
+ VC = TC = TR at break and even every dollar of revenue will have been spent.

3

The spreadsheet excerpt below shows the calculations:

Total Revenue 153,600 $
Fixed Cost 36,000 $
Maximum Weekly Capacity in Clients 4,800
Maximum Food Cost 24.50 $
BE Variable Food Cost = (Total Revenue - Fixed Cost) / Maximum Meals per week - Q


Question 2 is a budgeting question based on Chapter 2. It asks you to generate a quarterly budget with a
full-year summary using the information from Question 1 along with some additional data on the
seasonality of MMWC's fixed costs and the fact that the lowest food-supply bid was $.50 below the
break-even cost that was calculated in Question 1 or $24 per person per week. All of the input to the
budget calculations is shown in the spreadsheet excerpt above.




Revenue
Quarterly revenue equals the number of people served per week (4,800) times the number of
weeks in a quarter (given as 13) times the amount Millbridge pays MMWC for each person it
feeds ($32). That makes Quarterly revenue $1,996,800.

Expenses
Quarterly fixed expenses: The case tells us that fixed costs vary by quarter. They are $38,000 per
week in the winter (1st Quarter), $34,000 per week in the second quarter, $35,000 in the third
quarter and $37,000 in the fourth quarter. The calculations for quarterly fixed costs involves
multiplying the weekly fixed costs per quarter by the number of weeks in a quarter. For the first
quarter that is $38,000 13, or $494,000.
Quarterly variable food costs are calculated by multiplying the number of people fed (4,800) by the
number of weeks in a quarter (13) by the cost of the food ($24.50 $.50 $24.00). This is equal
to $1,497,000.

MMWC's Quarterly budget is shown below. Notice that each quarter is shown as a column with the
annual summary in the extreme right-hand column. That is standard practice.

Budget Quarter1 Quarter 2 Quarter 3 Quarter 4
Annual
Total
Revenue 1,996,800 $ 1,996,800 $ 1,996,800 $ 1,996,800 $ 7,987,200 $
Expenses
Variable Food Costs 1,497,600 1,497,600 1,497,600 1,497,600 5,990,400
Fixed Costs 494,000 $ 442,000 $ 455,000 $ 481,000 $ 1,872,000 $
Total Expenses 1,991,600 $ 1,939,600 $ 1,952,600 $ 1,978,600 $ 7,862,400 $
Surplus/(Deficit) 5,200 $ 57,200 $ 44,200 $ 18,200 $ 124,800 $



4

Let's make sure these calculations are correct. Here is what we know:
At average food costs of $24.50 per person per week, MMWC breaks even - the expected surplus
would be zero.
However, budgeted food costs were $24. That means MMWC will earn $.50 for every person it
feeds x 4,800 people x 52 weeks = $124,800. That is exactly what our budget shows.

Question 3 asked you to prepare variance analysis for the first quarter of the year. That was covered in
Chapter 8. A complete analysis of variance requires that we compute: (i) a revenue variance, (ii) a cost
variance, and add in the fixed-cost variance to get the full impact of the weather on MMWC's operations.

Lets start with the revenue variance. To do the analysis, we need to identify three factors:
the actual and budgeted Volumes,
the actual and budgeted Quantities, and
the actual and budgeted Rates.

We know the budgeted numbers from Question 1. Expected volume was 4,800 people x 13
weeks or 62,400 people fed while the actual volume was 4,600 people fed x 13 weeks. The budgeted rate
was $32 as was the actual rate. Quantity is a bit less obvious. You can either say that there is no measure
of resources used per person fed or us the variance convention that where there is no variation in resource
use, Quantity = 1. The revenue variance analysis for MMWC is in the spreadsheet excerpt below.

Column A Column B Column C
Actual Numbers Shown in Bold Actual Budget
Volume 59,800 62,400
Quantity (NA = 1) 1 1
Rate per unit 32.00 $ 32.00 $
Total Revenue 1,913,600 $ 1,996,800 $
Total Variance - Due to Volume (83,200) $ U
Total C - Total B
Total = V * Q * R


The total revenue variance is an Unfavorable ($83,200). All variance analyses always show the
amount of the variance and indicate whether that variance was favorable or Unfavorable. Note that all of
the revenue variance was due to volume.

The solution to the variance analysis shown below uses a spreadsheet variation on the
methodology shown in the text. . The numbers shown in bold are actual volume, quantity and cost/rate
numbers. The ones shown in regular type are budgeted values. The formulas used to calculate each of the
variance are shown in the column next to those calculations. Each calculation is based on the differences
between the total in each column that is indicated. Those totals equal volume * quantity * cost /rate.

The second component of the first-quarter variance was due to food costs. Here, there were two
things at work. The first was the weather which reduced Volume from the budgeted level of 4,800 people
per week to an actual of 4,600. The second was cost. budgeted Variable Cost was $24 per person while
actual Variable Cost was $23.25. As in part one, Quantity was equal to one for both budget and actual.
The expense variance analysis for MMWC is in the spreadsheet excerpt below.

5

Column A Column B Column C Column D Column E
Actual Numbers Shown in
Bold
Actual -
Change in
Cost
Change in
Quantity
Change in
Volume
Budget
Volume 59,800 59,800 59,800 62,400
Quantity (NA = 1) 1 1 1 1
Cost per unit 23.25 $ 24.00 $ 24.00 $ 24.00 $
Total Food Expense 1,390,350 $ 1,435,200 $ 1,435,200 $ 1,497,600 $
Total Variance 107,250 $ F
Volume Variance 62,400 $ F
Quantity Variance - $ F
Cost Variance 44,850 $ F
Total Variance 107,250 $ F
Sum of flexible Variances
Total Food Expense = Volume * Quantity * Cost
Calculations
Total D - Total C
Total C - Total B
Total E - Total B
Total E - Total D


The total expense variance is a favorable $107,250. Of that amount, a favorable $62,400 was due
to volume and there was a favorable $44,850 variance to cost. Note that the sum of the volume, quantity
and cost variances is equal to the total variance.

Notice that total variance appears twice in the both spreadsheet solutions. The first total-variance
calculation is based on the difference between the total budgeted revenue or expense and the actual. The
second calculation shows the sum of the Volume, Quantity and Rate or Cost variances. The second total
variance calculation is meant as a check on the flexible variance calculations. These two number must be
equal. If they are not, there is a mistake in your analysis.

The fixed-cost variance was equal to $2,000 per week times 13 weeks for an Unfavorable total
variance of ($26,000). The real question is what the overall impact of these factors was on MMWC's
operations and whether is helped or hurt them. Notice, when we bring all of the variances together, we
can talk about helping or hurting rather than just referring to the variances as Favorable or Unfavorable.
That is because we now know the overall impact. The aggregate impact of the weather and lower-than-
expected food prices is shown below.

Change in Revenue (83,200) $ U
Change in Fixed Costs (26,000) $ U
Change in Food Costs 107,250 $ F
Profit Increased/(Fell by) (1,950) $ U
-37.5%
Impact of Weather & Food Prices
Impact as % of Budgeted Profit/(Loss)


We now know that the weather cost MMWC $109,200 ($86,200 + $26,000) while lower food
prices offset $107,250 of that impact. Overall, MMWC, was $1,950 worse off than it expected to be.
While a $1,950 overall variance is not a significant amount in terms of projected annual profits $124,800,
it is 37.5% of expected 1st Quarter Profits of $5,200. That is a significant amount.

6

Question 4 is a capital budgeting problem from Chapter 5. You were asked to decide whether MMWC
should spend $700,000 for some new kitchen equipment. The equipment will allow MMWC to prepare
10,400 meals per day. This is an increase of 800 meals per day. That means that MMWC can feed 400
more people per week with the addition of the equipment.

Notice that we have only included the marginal cash flows from the additional people MMWC can
feed as a result of adding the equipment in our analysis. Marginal analysis was discussed in Chapter 4. If
we were include the cash flow MMWC expects to generate during the period by feeding the original
4,800 people, we would be including amounts that were not generated as a result of the decision we are
trying to evaluate. Capital budgeting analysis must be based on relevant cash flows. Whether or not
MMWC were to decide to acquire the equipment, it would still have cash flow equal to the difference
between its maximum break even food cost of $24.50 and the new food cost of $23.25 - a total of $1.25
per week per person fed. The relevant cash flows for the kitchen-equipment acquisition decision are those
generated by the marginal people fed by the equipment. If that were to prove to not be enough, MMWC's
management could choose to subsidize the equipment acquisition with funds from its core operation.
However, it should only make that decision after looking at whether the equipment can be justified on a
stand-alone basis and it knows how much of a subsidy it will need to provide.

Each of the additional 400 people that MMWC feeds will generate gross revenues of $32.
Offsetting this is the marginal (variable) cost of providing them with food. We know from the directors
instructions to use the new food bid that the marginal cost of food is $23.25 per person per week.
($24.50 $1.25). So, each additional person that MMWC feeds results in a marginal cash flow (the
excess of marginal revenue over marginal expenses) of $32 $23.25, or $8.75 per person per week.
Because the new equipment will let you feed 400 additional people per week, purchasing the equipment
generates $3,500 ($8.75 per person times 400 people) worth of cash flow each week.

To find out if this is enough to justify the purchase of the equipment, you need to do a net-present-
value analysis. Buying the equipment gives MMWC $3,500 of cash flow per week or $45,500 per quarter
(using 13 weeks per quarter). This is an annuity. The case tells you that your interest cost is 9% per
annum, 2.25% per quarter (9% interest per annum divided by 4 quarters in a year). The other calculations
for the periodic discount rate are similar.

Here is the problem setup:

Outflows

Purchase price = $700,000

Net Inflows for Quarterly Payments and Collections

PMT = Cash Flow = $3,500 number of weeks in the period that you have chosen.
(e.g., for a quarterly model $3,500 13 weeks = $45,500 per quarter)

I interest rate = 9% divided by the number of periods in the year (n) (e.g., for a
quarterly model 9%/4 quarters per year = 2.25% per quarter)

Present Value of the benefits = Present Value of Annuity (pmt) Cash Flow per period

Net Present Value = Present Value of the benefits minus purchase price

7

Based on weekly, quarterly and annual cash flows, the net present value of investing in the kitchen
equipment is greater than zero. In other words, the equipment more than pays for itself even after we take
the cost of capital into account. So, the organization should buy the equipment.

Note that the net present values derived from the weekly and quarterly calculations are different.
This is due to the timing and frequencies of cash flows in the two models. Theoretically, if MMWC gets
paid weekly, the weekly model is more correct. In a real world example, the timing of the collections and
disbursements from a capital investment could differ. In that case, you would lay the cash flows out on a
timeline in your spreadsheet and calculate the PV of each inflow and outflow - either separately or as
annuities if the timing allows for that - before finding the Net Present Value.

Capital Budget Analysis
Weekly
Collections
& Payments
Quarterly
Collections
& Payments
Annual
Collections
& Payments
PV of Equipment Purchase 700,000 $ 700,000 $ 700,000 $
Weekly Revenue from New Equipment 3,500 $ 45,500 $ 182,000 $
Annual Cost of Capital 9% 9% 9%
Number of Compounding Periods per Year 52 4 1
Periodic Discount Rate (I) 0.17% 2.25% 9.00%
Number of Periods (N) 260 20 5
Present Value of Benefit from Equipment 732,295 $ 726,349 $ 707,917 $
Net Present Value 32,295 $ 26,349 $ 7,917 $


Question 5 asks you to prepare an incremental budget for the coming year. Lets review what has
happened:

Weekly people fedup to 5,200 from 4,800, an increase of 400 per week
Revenue per person-weekunchanged at $32 per person per week
Food cost per person-week$23.25, down from $24.00
Acquired $700,0000 of new equipment with a 5-year useful life
Depreciation is on a straight-line basis
Borrowed $700,000 @ 8% interest with interest only payments in the 1st year
First quarter fixed costsup by $2,000 per week because of actual experience
Other quarterly fixed costsunchanged

MMWC will add depreciation on $700,000 worth of equipment with a 5-year life and a 10% residual
value. The depreciable basis for the equipment will be $700,000 - 10% x $700,000 = $630,000. Quarterly
depreciation will be the depreciable base ($630,000) divided by the number of quarterly depreciation
periods or 5 years x 4 quarters per year = 20 periods. Quarterly depreciation expense will be $31,500
($630,000/20 quarters).

MMWC borrowed $700,000 to acquire the equipment at an annual interest rate of 8%. Quarterly interest
expenses will be $700,000 x 8%/4 quarters = $14,000 per quarter.

The depreciation and interest calculations are shown below. Notice that both depreciation and interest
expenses are shown quarterly and aggregated for the full year. That illustrates the accrual concept from
Chapter 2. Under accrual accounting, expenses are shown when resources are used regardless of when
they are actually paid for.

8

Depreciation Expenses
Cost of Equipment 700,000 $
Residual Value 70,000 $
Depreciable Base 630,000 $
Useful Life 5
Annual Straight-Line Depreciation 126,000 $
Quarterly Straight-Line Depreciation 31,500 $
Interest Expense
Loan Amount 700,000 $
Annual Interest Expense 56,000 $
Quarterly Interest Expense 14,000 $


All of the rest of the calculations are the same as they are in Question 1. Using that methodology
and the revised data, we get the following budget:

Question 6: MMWC cannot expand beyond 5,200 people without adding more equipment and perhaps
adding additional space and staff.

Revised Budget Quarter1 Quarter 2 Quarter 3 Quarter 4
Annual
Total
Revenue 2,163,200 $ 2,163,200 $ 2,163,200 $ 2,163,200 $ 8,652,800 $
Enpenses
Variable Food Costs 1,571,700 $ 1,571,700 $ 1,571,700 $ 1,571,700 $ 6,286,800 $
Fixed Costs 520,000 442,000 455,000 481,000 1,898,000
Interest Expense 14,000 14,000 14,000 14,000 56,000
Additional Depreciation 31,500 31,500 31,500 31,500 126,000
Total Expenses 2,137,200 $ 2,059,200 $ 2,072,200 $ 2,098,200 $ 8,366,800 $
Surplus/(Deficit) 26,000 $ 104,000 $ 91,000 $ 65,000 $ 286,000 $





Reference

Finkler, S.A., Purtell, R.M., Calabrese, T.D., & Smith, D.L. (2013). Financial Management for Public,
Health, and Not-for-Profit Organizations, 4
th
Edition. Upper Saddle River, NJ: Pearson.