Tipton -Stop Decorating sells paint and paint supplies, carpet, and wallpaper at a single-store location in suburban Des Moines. Although the company has been very profitable over the years, management has seen a significant decline in wallpaper sales and earnings. Much of this decline is attributable to the Internet and ers free shipping and toll-free telephone numbers. Recent figures follow
Paint and Supplies carpeting wallpaper
Sales $380,000 $460,000 $140,000
Variable costs 228,000 322,000 $112000
Fixed costs 56,000 75,000 45,000
Total costs$284,000 $397,000 $157,000
operating income loss96,000 63,000 $(17,000)
Tipton is studying whether to drop wallpaper because of the changing market and accompanying If the line is dropped, the following changes are expected to occur:
The vacated space will be remodeled at a cost of $12,400 and will be devoted to an expanded line of high-end carpet. Sales of carpet are expected to increase by $120,000, and the line's overall contribution margin ratio will rise by five percentage points.
. Tipton can cut the wallpaper's fixed costs by 40 percent. Remaining fixed costs will continue to be incurred.
.Customers who purchased wallpaper often bought paint and paint supplies. Sales of paint and paint supplies are expected to fall by 20 percent
The firm will increase advertising expenditures by $25,000 to promote the expanded carpet line
1. Should Tipton close its wallpaper operation Show computations to support your answer?
2. Assume that Tipton's wallpaper inventory at the time of the closure decision amounted to $23,700 How would you have treated this additional information in making the decision?
3. What advantages might Internet- and magazine-based firms have over Tipton that would allow these organizations to offer deeply discounted prices-prices far below what Tipton can offer?
4. Build a spreadsheet: Construct an Excel spreadsheet to solve the requirement (1) above. Show how 3. the solution will change if the following information changes: sales were $400,000, $450,000, and $130,000, for paint and supplies, carpeting, and wallpaper, respectively.
Sunk costs are costs that have been incurred in the past and cannot be changed by future events or transactions. These costs are not relevant costs since they will not differ between alternatives. The inclusion of these costs in decision making will result in cost distortions and hence these costs should not be included in decision making. An example of sunk cost is the acquisition cost of an old machine in deciding whether to replace it with a new machine.
Answer and Explanation:
|Paint and Supplies||Carpeting||Wallpaper|
If wallpaper is closed
|Loss of wallpaper contribution||(28,000)|
|Additional profits from Carpet||65,000 (203,000 - 138,000)|
|Fixed cost savings from Wallpaper||18,000 (45,000 x 40%)|
|Loss in contribution from paint||(30,400) (152,000 x 20%)|
|Increased cost of advertising||(25,000)|
Tipton should not close wallpaper as the company will incur a loss of $12,800.
These are sunk costs and should be included in the decision.
There are less costs for internet and magazine based firms since:
a. they do not have to pay for retail shop rental
b. they do not have to pay wages of sales staff
c. they incur loss storage costs
They also have a wider sales audience since they are able to sell worldwide and are not restricted by shopping hours.
Spreadsheet cannot be attached here.
Learn more about this topic:
from Accounting 301: Applied Managerial AccountingChapter 9 / Lesson 12