Three years ago, Carrie Dungy and her brother-in-law Luke Barber opened FedCo Depart- ment Store. For the first two years, business was good, but the following condensed income results for 2011 were disappointing.

FEDCO DEPARTMENT STORE Income Statement

For the Year Ended December 31, 2011

Net sales $700,000 Cost of goods sold 553,000 Gross profit 147,000 Operating expenses Selling expenses $100,000 Administrative expenses 20,000 120,000 Net income $ 27,000

Carrie believes the problem lies in the relatively low gross profit rate (gross profit divided by net sales) of 21%. Luke believes the problem is that operating expenses are too high. Carrie thinks the gross profit rate can be improved by making both of the following changes. She does not anticipate that these changes will have any effect on operating expenses. 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 percentage points. Luke thinks expenses can be cut by making both of the following changes. He feels that these changes will not have any effect on net sales. 1. Cut 2011 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 2011 delivery expenses of $30,000 by 40%. Carrie and Luke 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 2012, assuming (1) Carries changes are implemented and (2) Lukes ideas are adopted.

(b) What is your recommendation to Carrie and Luke?

(c) Prepare a condensed income statement for 2012, assuming both sets of proposed changes are made.