Chapter 20: Q-23RQ (page 1120)
What is the margin of safety? What are the three ways it can be expressed?
Answer
Margin of safety is a cushion between profit and loss.
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What is a variable cost? Give an example.
What is the purpose of using the high-low method?
What effect does an increase in sales price have on contribution margin? An increase in fixed costs? An increase in variable costs?
Before you begin this assignment, review the Tying It All Together feature in the chapter.
Best Buy Co., Inc. is a leading provider of technology products. Customers can shop at more than 1,700 stores or online. The company is also known for its Geek Squad for technology services. Suppose Best Buy is considering a particular HDTV for a major sales item for Black Friday, the day after Thanksgiving, known as one of the busiest shopping days of the year. Assume the HDTV has a regular sales price of \(900, a cost of \)500, and a Black Friday proposed discounted sales price of \(650. Best Buy’s 2015 Annual Report states that failure to manage costs could have a material adverse effect on its profitability and that certain elements in its cost structure are largely fixed in nature. Best Buy, like most companies, wishes to maintain price competitiveness while achieving acceptable levels of profitability. (Item 1A. Risk Factors.)
Requirements
1. Calculate the gross profit of the HDTV at the regular sales price and at the discounted sales price.
2. Assume that during the November/December holiday season last year, Best Buy sold an average of 150 of this particular HDTV per store. If the HDTVs are marked down to \)650, how many would each store have to sell this year to make the same total gross profit as last year?
3. Relative to Sales Revenue, what type of costs would Best Buy have that are fixed? What type of costs would be variable?
4. Because Best Buy stated that its cost structure is largely fixed in nature, what might be the impact on operating income if sales decreased? Does having a cost structure that is largely fixed in nature increase the financial risk to a company? Why or why not?
5. In the Tying It All Together feature in the chapter, we looked at the cost of advertising. Is advertising a fixed or variable cost? If the company has a small margin of safety, how would increasing advertising costs affect Best Buy’s operating income? What would be the effect of decreasing advertising costs?
What are the three approaches to calculating the sales required to achieve the breakeven point? Give the formula for each one.
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