Question

Tipton One-Stop Decorating sells paint and paint supplies, carpet, and wallpaper at a single-store location in suburban Des Moines. Although the company has been very profitable over the years, management has seen a significant decline in wallpaper sales and earnings. Much of this decline is attributable to the Internet and to companies that advertise deeply discounted prices in magazines and offer customers free shipping and toll-free telephone numbers. Recent figures follow.

	Paint and Supplies						Carpeting				Wallpaper
Sales		$	380,000				$	460,000			$	140,000
Variable costs		$	228,000				$	322,000			$	112,000
Fixed costs			56,000					75,000				45,000
Total costs		$	284,000				$	397,000			$	157,000
Operating income (loss)		$	96,000				$	63,000			$	(17,000	)

Tipton is studying whether to drop wallpaper because of the changing market and accompanying loss. If the line is dropped, the following changes are expected to occur:

• The vacated space will be remodeled at a cost of $12,400 and will be devoted to an expanded line of high-end carpet. Sales of carpet are expected to increase by $120,000, and the line’s overall contribution margin ratio will rise by five percentage points.
• Tipton can cut wallpaper’s fixed costs by 40 percent. Remaining fixed costs will continue to be incurred.
• Customers who purchased wallpaper often bought paint and paint supplies. Sales of paint and paint supplies are expected to fall by 20 percent.
• The firm will increase advertising expenditures by $25,000 to promote the expanded carpet line.

Required:

1. 1-a. Calculate the income or loss if Tipton closes its wallpaper operation.
2. 1-b. Should Tipton close its wallpaper operation?
3. 2. Assume that Tipton’s wallpaper inventory at the time of the closure decision amounted to $23,700. How would you have treated this additional information in making the decision?
4. 3. What advantages might Internet- and magazine-based firms have over Tipton that would allow these organizations to offer deeply discounted prices—prices far below what Tipton can offer?

Answer 1

Answer 1-a:

Net Income will reduce by $ 12,800. (142,000 - 129200)

Calculation:

	Paint supplies	Carpenting	Wallpaper	Total
Sales	$       304,000	$ 580,000	$           -	$    884,000
Variable costs	$       182,400	$ 377,000	$           -	$    559,400
Contribution	$      121,600	$ 203,000	$           -	$    324,600
Fixed costs				$    195,400
Total costs				$    754,800
Operating income				$    129,200

Working Note:

Answer 1-b:

No, wallpaper operation should NOT be closed.

Answer 2:

As this is a sunk cost and is not relevant for decision making, this would not have been treated in decision making.

Answer 3:

The internet-based companies don't require large warehouses. So, their cost of storage would be less.

Further, internet-based companies can conduct their business worldwide/globally.

In case of any doubt, please feel free to comment.