Reference no: EM131045251

Case Study: CANOGA SPORTING GOODS, INC.

Canoga Sporting Goods (CSG) was a small business that manufactured bleacher seat pads that sports fans or picnickers could use to make wooden outdoor seating (or even convenient rocks) a bit warmer and more comfortable. The primary markets for CSG's product were college bookstores (to be sold to students and alumni) and specialty advertising firms (for use as corporate give-a-ways). The firm was organized the second half of 2001 and began selling products in 2002.

CSG had a policy of providing an annual "cost of living" increase for its assembly workers to maintain a constant annual cost of $25,000 per worker (1984 dollars). The production process requires one worker for every sixteen tons manufactured. As of January, 2005, up to ten of the assembly workers were provided by a local Sheltered Workshop Facility (a facility which provided and supervised disabled workers for product assembly and piece-work). This facility also rented necessary manufacturing space to CSG. Valley State Enterprises, a local manufacturing conglomerate with some excess capacity, provided the remaining workers and production space when more than the ten disabled workers were required. Valley State was also paid $25,000 (inflation adjusted) apiece for its workers plus an additional fee for the rental of equipment and space.

In addition to manufacturing labor, CSG employed a clerical worker and a general manager but no sales staff. Through December, 2005, sales were generated primarily by manufacturer's representatives who received a standard 5% of sales as their commission.

In January 2005, Valley State Enterprises purchased CSG. Valley State's management team immediately began supplementing sales efforts by adding the CSG products to their own manufacturers representatives' lines. Otherwise, they operated CSG without significant changes. The Valley State Enterprises managers soon found that while sales were growing, profits were shrinking. The management responded for the second half of 2005 by increasing the commission to their manufacturer's representatives from 5% to 6%. The sales force responded quickly and sales boomed.

By July 2006, Valley State's board of directors expressed some concern to management. Even though sales were up, the deal was not proving to be profitable. At the end of July 2006, the board of directors was informed that Valley State's management team had decided to reduce CSG's production staff by letting go those employees provided by the Sheltered Work Facility.

It is now autumn 2007. Valley State has been sued by a noted civil rights attorney claiming that closing down the Sheltered Work Facility manufacturing operation was a wrongful termination of the workers in the Sheltered Work Facility. Her court filings say that there was no valid business reason for selecting the disabled workers for layoff rather than the nondisabled workers; in part, the court filings claim that the layoff was wrongful because there was no economic justification for dismissing these workers who had been at least as productive, and profitable, as their nondisabled counterparts for so many years. The attorney claimed that this was obviously discrimination against the disabled and because of the discrimination, her ten clients will be unemployed for an average of 20 years each. The attorney is asking the court for a verdict of $20,000,000 as an appropriate award to her ten clients if she prevails in her action. She estimated this figure by computing 20 years x 10 clients x $25,000 = $5,000,000, doubling it to account for her fees, then doubling that to account for future inflation.

Required

You have been hired by Valley State's board of directors to help their attorney (and them) evaluate the claims in the lawsuit and determine whether the management team made the right decision. You have been asked to consider the following specific questions in preparing a report: (Use the guidelines for preparing a report on the course website.)

You remember from your Business School days the following concepts that you think might be useful here:

a. adjusting data for inflation (macroeconomics LDC concept 1)

b. marginal cost vs. average cost (microeconomics LDC concept 6)

c. opportunity cost vs. accounting cost (microeconomics LDC concept 1)

d. present value (financial accounting LDC concept 9)

e. duty to mitigate damages (business law LDC concept 5)

f. compensatory and punitive damages (business law LDC concept 9)

	Sales (Tons)	Average Real Price/Ton ($000)	Nominal Price ($000)	Nominal Revenue ($000)	Mfg. Rep's Commission Rate	Total Cost ($000)	Earnings before Tax ($000)
2001 2h	0	0	0	0	5%	129.840	-129.840
2002 1h	75	2.004	3.253	243.975	5%	251.454	-7.479
2002 2h	100	1.997	3.269	326.903	5%	309.175	17.728
2003 1h	150	2.004	3.315	497.280	5%	425.488	71.792
2003 2h	175	2.004	3.364	588.618	5%	492.402	96.216
2004 1h	185	2.004	3.423	633.271	5%	541.866	91.405
2004 2h	200	2.006	3.482	696.312	5%	605.633	90.680
2005 1h	225	2.001	3.535	795.292	5%	727.298	67.994
2005 2h	275	2.002	3.554	977.303	6%	988.973	-11.670
2006 1h	285	2.003	3.583	1021.067	6%	1042.133	-21.065

Problems-

You have been asked to consider the following specific questions in preparing a report to Valley State's board of directors.

P. 1. Was there a reasonable economic basis for the termination of the ten disabled workers (rather than the Valley State employees also working for CSG)? If you do not think there is enough information, what other data would you like to be provided? (Consider the opportunity cost of using the ten workers provided by the Sheltered Workshop in contrast to the opportunity cost of using existing Valley State staff and facilities.)

P. 2. Could CSG be a viable business? If so, under what conditions and what level of production (and, since production is directly related to production workers, employees)?

P. 3. Because Valley State's insurance company will not help pay for punitive damage awards, the directors are concerned whether an award of $20,000,000 would be compensatory, punitive, or some of each. As part of your analysis, you will need to consider the time value of money and use an interest rate for discounting. You remember reading that "corporate bond rates" are appropriate for discounting workers' earnings to present value. Suppose the current rate is 7%. However, you also remember that since the losses are in terms of "real dollars", you will need to adjust the interest rate to an approximately "real rate" by subtracting the inflation rate. As an estimate of the inflation rate, use the median inflation rate implied by the real and nominal prices in Table 1 of the case.

P. 4. a. Assume that with reasonable efforts to mitigate, the terminated employees could find comparable work within one year of termination. What is a reasonable estimate of the employees' economic losses due to the termination? (The value should be expressed as a present value, reflecting the time value of future payments.)

b. Assume that the jury believes the plaintiffs' claim that the workers will be unemployed for an average of twenty years each. What is a reasonable estimate of the employees' economic losses due to the termination? (The value should be expressed as a present value, reflecting the time value of future payments.)

P. 5. Suppose that it is discovered that the workers who were terminated have not sought new employment but are instead waiting for the lawsuit to go to trial. Would this have any impact on the calculation of their economic losses?

Q. 6. Suppose that punitive damages were allowed by the court in the event of a plaintiffs' verdict. What is an appropriate level of punitive damages? If there is not enough information to determine this, what other data would you like the directors to provide to you?