Question

Charlie’s Furniture Store has been in business for several years. The firm's owners have described the store as a "high-price, high-service" operation that provides lots of assistance to its customers. Margin has averaged a relatively high 35% per year for several years, but turnover has been a relatively low 0.4 based on average total assets of $400,000. A discount furniture Store is about to open in the area served by Charlie's, and management is considering lowering prices to compete effectively.

Required:

a. Calculate current sales and ROI for Charlie’s Furniture Store. (Round your "ROI" to 1 decimal place.)

b. Assuming that the new strategy would reduce margin to 20%, and assuming that average total assets would stay the same, calculate the sales that would be required to have the same ROI as Charlie’s currently earns. (Do not round intermediate calculations.)

c. Suppose you presented the results of your analysis in parts a and b of this problem to Charlie, and he replied, "What are you telling me? If I reduce my prices as planned, then I have to practically double my sales volume to earn the same return?" Given the results of your analysis, what is the actual amount of increase in sales required? (Do not round intermediate calculations.)

d. Now suppose Charlie says, "You know, I'm not convinced that lowering prices is my only option in staying competitive. What if I were to increase my marketing effort? I'm thinking about kicking off a new advertising campaign after conducting more extensive market research to better identify who my target customer groups are." In general, explain to Charlie what the likely impact of a successful strategy of this nature would be on margin, turnover, and ROI.

Answer 1

SOLUTION

A. ROI = Margin * Turnover

= 35% * 0.4 = 14%

Current sales = Average total assets * Turnover

= $400,000 * 0.40 = $160,000

B. Turnover = 14 / 20% = 70%

Current sales = Average total assets * Turnover

= $400,000 * 0.70 = $280,000

C. If margin gets reduced sales increases by $120,000 (280,000-160,000) at ROI 14%. Thus increasing the sales by 40% is a good proposition.

D. This strategy could increase the operating expenses and reduce the margin, might also have a positive impact on sales volume, so ROI might still increase.