Question

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?

Short answer

The gross per unit at regular sales is $400and at discounted sales price is $150.The number of units to be sold to make the same total gross profit is 400 units. Fixed costs do not change with the level of activity, but the variable cost does. If the sales of the company decrease, then operating income will also decrease. Advertising cost is a fixed cost; if it increases, operating income decreases, and if it decreases, then operating income increases.

Step-by-step solution

Computation of gross profit at regular sales and discounted sales price

$\begin{array}{c}\mathrm{Gross}\mathrm{price}\mathrm{per}\mathrm{unit}\mathrm{at}\mathrm{regular}\mathrm{sales}=\mathrm{Sales}\mathrm{price}\mathrm{per}\mathrm{unit}-\mathrm{Cost}\mathrm{per}\mathrm{unit}\\ =900-500\\ =\$400\end{array}$

$\begin{array}{c}\mathrm{Gross}\mathrm{price}\mathrm{per}\mathrm{unit}\mathrm{at}\mathrm{discounted}\mathrm{sales}\mathrm{price}=\mathrm{Sales}\mathrm{price}\mathrm{per}\mathrm{unit}-\mathrm{Cost}\mathrm{per}\mathrm{unit}\\ =650-500\\ =\$150\end{array}$

Computation of sales unit for making a gross profit last year

Particulars
Number of HDTVs sold last year per store	150
Number of stores	1,700
Total sales last year (150*1,700)	$255,000
Gross profit per unit (900 – 500)	$400
Gross profit earned last year (255,000 x 400)	$102,0000
Sales per unit at reduced prices	$650
Cost per unit	$500
Gross profit at reduced prices per unit (650 – 500)	$150
Units to be sold to earn profit as last year (102,000,000/150)	680,000
Units to be sold by each year (680,000/1,700)	400

Costs which are fixed and variable

The company will consider those costs as fixed costs that do not change or vary with the level of activity, and the cost which are most likely to change or vary with the change in the production level or sales volume will be considered variable costs.

Part 4

As the company's cost structure is majorly fixed in nature, it will decrease the contribution margin when the sale of the company decreases. A fall in the contribution margin will also lead to a fall in the operating income of the company.

Part 5

The advertising cost is a fixed costas it does not change with the change in the level of sales. In case the company has a low margin of safety and the advertising costs still increase. It will similarly decrease the operating income, and if advertising costs decrease, then operating income will increase.