BYP9-6

Payton Furniture Corp. is nationally recognized for making high-quality products. Management is concerned that it is not fully exploiting its brand power. Paytons production mangers are also concerned because their plants are not operating at anywhere near full capacity. Management is currently considering a proposal to offer a new line of affordable furniture.

Those in favor of the proposal (including the vice president of production) believe that, by offering these new products, the company could attract a clientele that it is not currently servicing. Also, it could operate its plants at full capacity, thus taking better advantage of its assets.

The vice president of marketing, however, believes that the lower priced (and lower margin product would have a negative impact on the sales of existing products. The vice president believes that $10,000,000 of the sales of the new product will be from customers that would have purchased the more expensive product but switched to the lower-margin product because it was available. (This is often referred to as cannibalization of existing sales.) Top management feels, however, that even with cannibalization, the companys sales will increase and the company will be better off.

The following data are available.

(In thousands) Current results Proposed Results Proposed Results

Without Cannibalization with Cannibalization

Sales revenue $45000 $60,000 $50000

Net income $12000 $13500 $12000

Average total assets $100,000 $100,000 $100,000

Instructions

• Compute Paytons return on assets, profit margin, and asset turnover, both with and without the new product line.
• Discuss the implications that your findings in part (a) have for Paytons decision.
• Are there any other options that Payton should consider? What impact would each of these have on the above ratios?