ZS Associates Case Study Questions 2024

Question 5:

Assume you are the manager for a consultancy firm. You received the following information and are expected to solve your clients questions:

 How would you approach this issue?

Digilant Toys is a high-end toys maker in the country of Moldova. Moldova, officially the Republic of Moldova, is a landlocked country in Eastern Europe located between Romania to the west and Ukraine to the north, east, and south. Moldova declared itself an independent state with the same boundaries as the Moldavian Soviet Socialist Republic in 1991 as part of the dissolution of the Soviet Union. The total population of the country amounted to 4 million (2004 Moldovan census).

The owner of Digilant Toys business has seen substantial change in his market in recent years and is contemplating the future of his business. Up until now, he has been in the business of building high-quality, handcrafted toys largely by hand with a skilled labor force. Recently, however, he has become aware of a new technology that would allow him to build machine-made toys with much less labor.

The following data is also provided to you:

1. Investment – Investing in the new technology will cost the firm $1M.
2. Cost Savings – Material costs remain the same, but labor costs are reduced by 50%.
3. Proprietary Nature of Technology – The new toy-making technology is being offered for sale by a machine tool company, who holds the patent. They are not offering exclusivity to any customers (i.e. they will sell to Digilant Toys’s competitors if possible).
4. Competitive Threat – It is not known whether the competitors have acquired or are planning to acquire this new toy-making technology.
5. Customer Preferences – While the machine-made toys are not “handmade”, the quality perceived by the customer is the same or better. It is believed that the customer will be indifferent between the quality and appearance of hand-made and machine-made toys.
6. Brand Impact – The candidate may argue that machine-made toys might negatively impact Digilant Toys’s brand. If so, ask them how they would test this (e.g. consumer research), but tell them to assume that it would have negligible impact.
7. Assets – Since the firm has been building toys by hand, the fixed assets are essentially only the land and improvements. These are owned outright by the company. – Book Value of Land: $20,000, Book Value of Improvements: $80,000, Years Owned: 48 and Average Real Estate Appreciation: 6% / years

The following market details are also given:

1. Population of Moldova: 4 million
2. Population Growth: 0%
3. Average Life Expectancy: 75 years
4. Age Distribution: assume a flat age distribution, i.e. same number of people at every age.
5. Burial Customs: 75% of people use toys.
6. Price – toys are priced at $5,000 for hand-made high-end toys.
7. Costs – Material accounts for 10% of the direct cost, while labor accounts for the other 90%. COGS is $4,800 per toy. Fixed costs for the business are $700,000 per year. Assume all assets are fully depreciated and ignore taxes.
8. Competition – The client has a 10% market share and a relative market share of about 1 (if asked, you may explain that relative market share is the ratio of the company’s market share to that of its nearest competitor.)
9. Market Trends, Regulation, etc. – If asked about any exogenous factors, simply tell the candidate to assume that the market is expected to continue as it currently is.

You as a manager of the consultancy firm are supposed to answer these questions:

1. What strategic alternatives should the owner of the toys business consider?
2. Calculate the market size.
3. Calculate the value of the company toy’s business
4. What is the value of the company if it were shut down and the assets were sold?
5. What would the value of the company be if the owner invests in the new technology?

Answers:

Answer 1:

We need to decide firstly whether to stay in the toys business at all and if so, whether he uses the new technology:

Option 1: Sell the business to a third party

Option 2: Sell the assets of the company and shut it down

Option 3: Keep operating as is

Option 4: Keep operating and invest in the new technology

Answer 2:

(4 million) x (1/75) * (75%) = 40,000 toys purchased per year.

Answer 3:

Margin per toys = $5,000 – $4,800 = $200

Contribution Margin = $200 per toys x 40,000 toys x 10% market share = $800,000

Profit = Contribution Margin – Fixed Costs = $800,000 – $700,000 = $100,000

Assuming a discount rate of 10% (candidate can assume anything reasonable here as long as they are consistent later), a perpetuity with cash flows of $100,000 per year has a present value of $100,000 / 0.1 = $1 Million. So the current business is worth $1M whether they keep it or sell it.

Answer 4:

Using the “rule of 72″, a 6% growth rate will double the investment every 72/6 = 12 years. Since the property was held for 48 years, the current value will be $100K * (2 x 2 x 2 x 2) = $1.6M.

Since the assets ($1.6M) are higher than the value of the discounted cash flows ($1M), then it would make more sense to liquidate the business and sell the assets.

Answer 5:

Since the company has no proprietary control over the technology, it is likely that competitors will also acquire it, resulting in an overall lowering of the industry cost structure. If this is the case, price will also fall as competition cuts price in an attempt to gain share. If we assume that gross margins remain the same, since the industry competitive structure has not changed we can calculate the new margin contribution as follows:

Gross Margin = $200 / $5,000 = 4%

Labor Cost = (4800 x 90%) x 50% = $2,160

Material Cost = 4800 x 10% = $480

COGS = $2,160 + $480 = $2,640

Price = $2,640 / (1 – 4%) = $2,750

Contribution Margin = $2,750 – $2,640 = $110 per toy

Profit/Loss = $110 * 4,000 – $700,000 = -$260,000

So the introduction of the new technology to the market might be expected to reduce industry profits, making this business completely unprofitable.