Question

Electronic King sells Televisions, Stereo Equipment and Compact Discs (CDs) at a single store location in Barrie, Ontario. Although the company has been profitable over the years, management has seen a significant decline in CD sales and earnings. Much of the decline is attributable to the Internet and to companies such as Amazon.com that advertise discounted prices and delivery to the door shipping. Recent results are as follows: Sales Televisions $190,000 Stereo Equipment $230,000 CDs $70,000 Variable costs Fixed costs Total costs 114,000 28,000 142,000 161,000 37.500 198,500 56,000 22,500 78,500 Operating Income (loss) $48,000 - $31.500 $(8,500) Management is studying whether to drop CD sales because of the changing market and accompanying loss. If CDs are dropped the following changes are expected to occur: • The space vacated by the CD department can be remodeled at a cost of $6,200 and will be devoted to a new line of high-end stereo equipment. • Sales of stereo equipment is expected to increase by $60,000 with the introduction of a high-end brand of stereo and the overall stereo equipment contribution margin ratio will increase by 5%. Electronic King will increase advertising expenses by $12,500 to promote its new line of high-end stereo equipment. Electronic King can cut CD fixed costs by 40%. Remaining fixed costs will continue to be incurred. • Sales of Televisions are expected to decline by 20% if the CD product line is dropped. a) Should Electronic king close its CD department? Show your calculations? b) Assume that Electronic King's CD inventory at the time of the closing decision amounted to $12,000. How would you treat this additional information in making the CD close/no-close decision?

Answer 1

CDs Sales Variable costs Contribution margin Fixed costs Operating income (loss) With CD is in operation Televisions Stereo Equipment 190,000 230,000 114,000 161,000 76,000 69,000 28,000 37,500 48,000 31,500 Company 70,000 490,000 56,000 331,000 14,000 159,000 22,500 88,000 (8,500) 71,000 Contribution Margin Ratio 76,000 190,000 69,000 230,000 14,000 70,000 Contribution Margin Ratio 40% 30% 20% CDs Company Sales (190000 *( 1-.20)),(230000 +60000) Variable costs (114000 *(1-.20)), (290000-101500) Contribution margin (290000 *35%) Fixed costs (37500 +6200+12500),22500 *(1-.40) Operating income (loss) Without CD is in operation Televisions Stereo Equipment 152,000 290,000 91,200 188,500 60,800 101,500 28,000 32,800 45,300 442,000 279,700 162,300 97,700 64,600 56,200 13,500 (13,500) Contribution Margin Ratio 0 60,800 152,000 101,500 290,000 Revised Contribution Margin Ratio 40% 35.00%

Electronic King should not close its CD department as it has reduced the operating Income from $71,000 to $64,600. 71 b) The additional information on Inventory of CD will not change the decision. The CD inventory amount $12,000 is one time Inventory and could have been sold if CD division is closed. But closing the CD division is a continuous decision for many years. 74