Problem
Short-term Decision Making
Electronic King sells Televisions, Stereo Equipment and Compact Disc's (CD's) at a single store location in Barrie, Ontario. Although the company has been profitable over the years, management has seen a significant decline in DVD sales and earnings. Much of the decline is attributable to the Internet and to companies such as Spotify, Apple Music, and Amazon Music who offer streaming of millions of music titles.
Recent results are as follows:
|
|
Televisions
|
Stereo Equipment
|
DVD's
|
|
Sales
|
$190,000
|
$230,000
|
$70,000
|
|
Variable costs
|
114,000
|
161,000
|
56,000
|
|
Fixed costs
|
28,000
|
37,500
|
22,500
|
|
Total costs
|
142,000
|
198,500
|
78,500
|
|
Operating income (loss)
|
$48,000
|
$31,500
|
$(8,500)
|
Management is studying whether to drop DVD sales because of the changing market and accompanying loss. If DVD's are dropped, the following changes are expected to occur:
1) The space vacated by the DVD department can be remodeled at a cost of $6,200 and will be devoted to a new line of high-end stereo equipment.
2) Sales of stereo equipment is expected to increase by $60,000 with the introduction of a high-end brand of stereo and the stereo equipment contribution margin ratio will increase by 5%.
3) Electronic King will increase advertising expenses by $12,500 to promote its new line of high-end stereo equipment.
4) Electronic King can cut DVD fixed costs by 40%. Remaining fixed costs will continue to be incurred.
5) Sales of Televisions are expected to decline by 20% if the DVD product line is dropped as customers who purchased DVD's often bought televisions.
Task
A. Should Electronic King drop DVD's from its product offering? Show detailed computations to support your answers.
B. Assume that Electronic King's DVD inventory at the time of the decision to drop the product amounted to $23,700. How would you have treated this additional information in making the decision in A?