Question

After graduation from college, you opened a swimwear store, called the Zig Zag, on South Padre Island. The building you located is 400 square feet and had been vacant for 18 months. Because of the limited amount of start-up capital you had to invest in the business, you move into the building without remodeling either its exterior or its interior.

During the first year the Zig Zag had 13,400 visitors of whom 3,350 made a purchase. The average transaction size was $38. The Zig Zag operates on a gross margin of 55 percent and has annual fixed operating expenses of $30,000. Variable costs were 15 percent of sales. The two primary fixed expenses are rent of $1,100 a month and salaries of $1,200 a month. You keep all profits in the business to reinvest in inventory and other immediate business needs.

Because your first year was profitable, you are now considering remodeling the store. Your landlord will not help with these expenses. To paint the exterior would cost $1,400. For the interior, you are thinking of tiling the floor in a zigzag pattern, which will cost $1,600. In addition, new lighting and some new fixtures would cost $4,000.

You believe these changes will increase traffic by 10 percent and that your closure or conversion rate will increase to 30 percent.

Will your proposed changes pay for themselves the first year? Explain how you came to your conclusion.

Answer 1

Y1 Total Sales = 3350*$38 = $127,300

Less Var costs = 15%* $127,300 = $19,095

Total COnt = $108,205

Less FOC = $30000

Less Fixed exp -Rent = 12*$1100

Less Fixed exp-Salary =12*$120 ($57,600)

Net Income = $50,605 .............(A)

In Y2, Extra Cost of remodeling = $1400+$1600+$4000 = $7,000 ...(X)

Total Sales = (1.10*13400)*30%*$38 = $168,036

Less Var cost = 15%*$168,036 = $25,205

Total COnt = $142,831

Less Fixed costs (30000+12*1100+12*1200) = 57,600

Net Income in Y2 = $85,231 ............(B)

So Net Inc in Y2-Net Inc in Y1 = B-A = $85,231 - $50,605 = $34,626 ...(Y)

As Increase in Net Inc in Y2 (Y) is considerably greater than Cost of remodelling (X), the proposed changes have paid off in the year itself.