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 40% per year for several years, but turnover has been a relatively low 0.6 based on average total assets of $3,000,000. 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. b. Assuming that the new strategy would reduce margin to 30%, 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. 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 increase my sales volume by 50% to earn the same return?" Given the results of your analysis, what is the actual amount of increase in sales required? 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 e. What are the other alterrative strategy that might help Charlie maintain the competitiveness of his business

Answer 1

a.

Average assets	3,000,000.00
Turnover Ratio	0.6
Formula	Net Sales/Average total assets
ie.,	0.6 = Net sales/3000000
So Net Sales	1,800,000.00
Gross Margin	40% (given)
So,	720,000.00
Hence, Current Sales	1,800,000.00
ROI = 720,000/3000000*100	24%

b.Since ROI and Average Total Assets are the same, Margin will be = 3000,000*24% = 720,000. This is 30% of sales. So Sales => 720,000/30*100 = 2400000.

c. With reduced prices total sales has to be increased from $ 1800,000 to $ 2400000. Ie increase of $ 600,000. or 600,000/1800,000*100 = 33% and not 50%.

d. Marketing strategy involves costs usually fixed in nature viz salaries, promotion, advertisement costs or variable like sales commission and volume based incentives. Hence, such marketing should boost up the contribution to that extent It recovers the variable costs then the fixed marketing costs and provide for 40% on sales margin and finally maintain ROI 30% on assets.

e. Charlie can focus on cutting down his costs. Presently 60% of sales are his costs (100% - 40% margin). Cutting down costs can also help him in reducing prices thus generate higher volume of sales. The margins due to reduced costs also can be maintained easily even though prices are reduced.