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 more capital intensive than Automobile Inc., and relies more on fixed assets for its production. You are given the following information about the companies for year X1 (amounts in millions):
$\begin{array}{ll}
\text { Cars Inc.: } & \text { Automobile Inc.: } \
\text { Sales } \$ 4,376 & \text { Sales } \$ 2,746 \
\text { COGS } \$ 3,785(68.43 \% \text { - variable }) & \text { COGS } \$ 2,553(84.76 \% \text { - variable })
\end{array}$
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%, year X5 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.

Question

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 more capital intensive than Automobile Inc., and relies more on fixed assets for its production. You are given the following information about the companies for year X1 (amounts in millions):
$\begin{array}{ll}
\text { Cars Inc.: } & \text { Automobile Inc.: } \
\text { Sales } \$ 4,376 & \text { Sales } \$ 2,746 \
\text { COGS } \$ 3,785(68.43 \% \text { - variable }) & \text { COGS } \$ 2,553(84.76 \% \text { - variable })
\end{array}$
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%, year X5 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.

Quizplus · Accepted Answer

The Answer is a. Cars Inc. is more capital intensive than Automobile Inc. and hence has a higher proportion of fixed costs and a lower proportion of variable costs. Since Cars Inc. offers a higher end product than Automobile Inc., and given the cost structure it is likely that Cars Inc. will have a higher price for its products and a higher gross margin percentage.

a. Cars Inc. is more capital intensive than Automobile Inc. and hence has a higher proportion of fixed costs and a lower proportion of variable costs. Since Cars Inc. offers a higher end product than Automobile Inc., and given the cost structure it is likely that Cars Inc. will have a higher price for its products and a higher gross margin percentage. d. As expected, our calculations show that Cars Inc. has an average gross margin percentage of 14.46% as opposed to 7.46% for Automobile Inc. Additionally, the gross margin percentage for Cars Inc. has a higher standard deviation ratio to the mean as compared to Automobile Inc. (0.0538 and 0.0474 for Cars Inc. and Automobile Inc., respectively). This higher variability results from Cars Inc.'s higher proportion of fixed costs.

d. As expected, our calculations show that Cars Inc. has an average gross margin percentage of 14.46% as opposed to 7.46% for Automobile Inc. Additionally, the gross margin percentage for Cars Inc. has a higher standard deviation ratio to the mean as compared to Automobile Inc. (0.0538 and 0.0474 for Cars Inc. and Automobile Inc., respectively). This higher variability results from Cars Inc.'s higher proportion of fixed costs.

Cars Inc and Automobile Inc The Car Manufacturing Industry Expects the Following Increases in Sales