Situation 1

Honest Charlenes Auto Dealer purchases used cars at auto auctions and sells them retail. The autos, on average, sell for approximately $20,000 each and cost Charlene $13,500. The costs that the company incurs in a typical month are listed below:

Costs Cost Formula

Selling:

Advertising $3,900 per month

Preparation of Autos for Delivery

$ 900 per auto sold

Sales salaries & commissions $4,100 per month, plus 7% of sales

Utilities (same every month) $5,200 per month

Depreciation on sales facility $4,500 per month

Administrative:

Executive salaries $12,800 per month

Depreciation on office equipment $2,200 per month

Clerical staff salaries $3,600 per month

Insurance $1,900 per month

During April, Honest Charlenes sold 75 autos.

Required

Prepare a traditional income statement as of April 30. All numbers should be rounded to the nearest dollar.

Prepare a contribution format income statement as of April 30. All numbers should be rounded to the nearest dollar. Show costs and revenues on both a total and per unit basis down through the contribution margin.

What costs does the Contribution Margin Income Statement format isolate (make apparent) that the Traditional Income Statement format does not?

For the contribution format income statement, why might it be misleading to show the fixed costs on a per unit basis?

Situation 2

Newago, Inc. is strapped for cash for investment projects and must decide which of four projects it will fund. Below are the projects and information about them:

Life of

Net the Internal

Investment Present Project Rate of

Project Required Value in Years Return

1 $80,000 $210,000 6 13%

2 $750,000 $340,000 10 17%

3 $845,000 $333,000 7 12%

4 $695,000 $202,000 5 18%

Required

Compute the project profitability index for each project.

Rank the four projects in order of preference in terms of :

Internal rate of return

Project profitability index

Net present value.

Which of the three rankings above do you prefer? Why? What are the strengths and weaknesses of each method?

Situation 3

Gopher Gulch Corp. is a little two-store retailer operating in a local market. Its problem is that one store in the company is losing money while the other one is making money, based on company financial reports, causing the company as a whole to lose money. The most recent income statement for Gopher Gulch Corp. is given below:

Store 1 Store 2 Total Sales $976,000 $1,145,000 $2,121,000

Variable costs (593,000) (685,000) (1,278,000) Contribution margin 383,000 460,000 843,000

Traceable fixed costs (470,000) (269,000) (739,000)

Store segment margin ( 87,000) 191,000 104,000 Common fixed costs (116,000) (85,000) (201,000)

Net operating income (loss) $(203,000) $ 106,000 $ (97,000)

Because of its poor showing, Gopher Gulch Corp. officials are considering closing Store 1. However, management and the workers at Store 1 say, Not so fast! A study by a consultant hired by Gopher Gulch Corp. officials show that if Store 1 is closed, 39 percent of its traceable fixed costs will continue unchanged. The study also shows that closing Store 1 would result in a 28 percent decrease in sales in Store 2. The company allocates common fixed costs, such as your corporate officials salaries and advertising costs, to the stores on the basis of square footage of the stores. Management and workers at Store 1 claim that Store 1 is being unfairly targeted for closure.

Your uncle, the CEO of Gopher Gulch Corp., knows that you are a student in the prestigious Delta State University Integrated Master of Business Administration (IMBA) Program, and so has turned to you for advice on what to do.

Required

Compute Gopher Gulch Corps total net operating income (loss) if Store 1 is closed. (Hint: The answer will entail determining the lost contribution margins for Store 1 and Store 2 offset by the amount of fixed costs shed by closing Store 1. Pay close attention to the percentages listed above.)

Compare the total net income (loss) when the two stores are open with the total net operating income (loss) when only Store 2 is open. Is the total net operating income greater (total net operating loss smaller) when two stores are open or when only Store 2 is open?

Based on your calculations above, what should you tell your uncle regarding Store 1? In other words, should Store 1 be closed or do store management and workers have a basis for their claims and both stores should remain open?

Given the profit or loss overall for the company, what is your recommendation to your uncle regarding the capital invested in Gopher Gulch Corp.? In other words, eyeball the value of the assets of the company versus the profit (loss) generated by those assets. Should the company continue to operate one (or both) stores, or should the company get what money it can for the assets and invest that money elsewhere (such as in another business, bonds, stocks, T-bills, etc.)?

Required:

Variable costs for each store individually is what percentage of that stores sales revenue?

Total fixed costs for each store individually is what percentage of total sales revenue for that store?

Do fixed costs for each store individually appear to be reasonable, unreasonable, or cannot be determined. Explain your answer.

Is net operating income as a percentage of sales revenue for Store 2 reasonable? Explain your answer.

Traceable fixed costs for each store individually is what percentage of the individual stores sales revenue?

What percentage of total company sales revenue does each store provide?

What percentage total common fixed costs for Gopher Gulch Corp. is charged individually to each of the stores?

Does the allocation of common fixed costs to each store appear to be equitable in light of the sales revenue generated individually by each store?

On what basis do you believe that common costs should be allocated in Gopher Gulch Corp.? (Be specific.)

Based on your review of various costs for each of the stores individually, why do you think Store 1 has a net operating loss?

As a turnaround specialist, what steps do you recommend to turn Gopher Gulch Corp. around into a profitable retail company? (Be specific.)

Do the costs relative to sales revenue appear to your practiced professional eye to be excessive, low, or within a reasonable range?

Analyze the distribution of the costs between the two stores. Do you see anything that seems awry?

What effect does what you identified in the question immediately before this one have on determination of store operating costs?

In answering the questions above, you have examined sales revenue, various categories of cost, costs relative to sales revenue, the distribution of costs between stores, and the contribution margins of each store. After doing all of these analyses, what is your advice to your uncle on how best to make Gopher Gulch Corp. profitable, or is that not even possible?