Payton Furniture Corp. is nationally recognized for making high-quality products

Question

Payton Furniture Corp. is nationally recognized for making high-quality products. Management is concerned that the company is not fully exploiting its brand power. Payton’s production managers are also concerned because their plants are not operating at 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. It could also 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 company’s sales will increase and the company will be better off.

The following data are available: (In Thousands)

Current Results - Sales Revenue: $45,000, Net Income: $12,000, Average Total Assets: $100,000.

Proposed Results without Cannibalization - Sales Revenue: $60,000, Net Income: $13,000, Average Total Assets: $100,000

Proposed Results with Cannibalization - Sales Revenue: $50,000, Net Income: $12,000, Average Total Assets: $100,000

Instructions: Compute Payton’s 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 on Payton’s decision.

Are there any other options that Payton should consider? What impact would each of these have on the above ratios?

Explanation / Answer

Details Without new prodcut Line With new product Line without cannibalization With new product Line with cannibalization a Sales Revenue                  45,000                    60,000                  50,000 b Net Income                  12,000                    13,000                  12,000 c Average Total Assets                  100,000                  100,000                100,000 Return on Assets =b/c= 12.0% 13.0% 12.0% Profit Margin =b/a= 26.7% 21.7% 24.0% Asset Turnover =a/c=                       0.45                         0.60                       0.50 The addition of new line without cannibalization increases the total net income and asset   turnover and return on assets but net margin is lowest. The addition of new line with cannibalization does not increase the total net income but asset   turnover increase and net margin goes down. From Asset Turoover perspective new line addition is good , but it adds to net income when there is cannibalization . The company needs to think of adding new line with better margin and products that   do not cannibalize existing sales. In that case the Asset turnover, Return on Assets and   net Margin all ratios will improve.

Related Questions

Navigate

• Browse (All)
• Browse P
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.