Three years ago Kathy Webb and her brother-in-law John Utley opened FedCo Department Store. For the first 2 years, business was good, but the following condensed income results for 2001 were disappointing:

Kathy believes the problem lies“in the relatively low gross profit rate (gross profit divided by net sales) of 22%. John believes the problem is that operating expenses are too high. Kathy thinks the gross profit rate can be improved by making two changes: (1) Increase average selling prices by 17%; this increase is expected to lower sales volume so that total sales will increase only 6%. (2) Buy merchandise in larger quantities and take all purchase discounts; these changes are expected to increase the gross profit rate by 3%. Kathy does not anticipate that these changes will have any effect on operating expenses.
John thinks expenses can be cut by making these two changes: (1) Cut 2001 sales salaries of $60,000 in half and give sales personnel a commission of 2% of net sales.
(2) Reduce store deliveries to one day per week rather than twice a week; this change will reduce 2001 delivery expenses of $30,000 by 40%. John feels that these changes will not have any effect on net sales.
Kathy and John come to you for help in deciding the best way to improve net income.
Instructions With the class divided into groups, answer the following:

(a) Prepare a condensed income statement for 2002 assuming (1) Kathy’s changes are implemented and (2) John’s ideas are adopted.

(b) What is your recommendation to Kathy and John?

(c) Prepare a condensed income statement for 2002 assuming both sets of proposed changes are made.

(d) Discuss the impact that other factors might have. For example, would increasing the quantity of inventory increase costs? Would a salary cut affect employee morale?
Would decreased morale affect sales? Would decreased store deliveries decrease customer satisfaction? What other suggestions might be considered?
COMMUNICATION ACTIVITY

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FEDCO DEPARTMENT STORE Income Statement For the Year Ended December 31, 2001 Net sales Cost of goods sold Gross profit Operating expenses Selling expenses Administrative expenses Net income $700,000 546,000 154,000 $100,000 25,000 125,000 $ 29,000