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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.
Gross Profit= Sales Price – Cost of Goods Sold
$900 – $500 = $400 gross profit at the regular sales price
$650 – $500 + $150 gross profit 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?
Number of TVs sold last year x Number of stores= Total Sales Last Year
Total Sales x Gross Profit per Unit = Gross Profit Earned last year
(1700 x 150) x 400 = 102,000,000
Gross Profit Earned last year / Gross profit at the discounted sales price = units to be sold to earn same profit as last year
102,000,000/150 = 680,000
Total Units to be Sold / Number of stores = Units to be sold at each store
680,000/1700 = 400 units to be sold at each store
3. Relative to Sales Revenue, what type of costs would Best Buy have that are fixed? What type of costs would be variable?
Fixed costs are defined as costs that do not change in total over ranges of volume of activity (Miller-Nobles et al., 2018). Therefore, for Best Buy fixed costs would include items such as rent, depreciation expenses, or even general yearly maintenance on machines. Variable costs, however, are costs that increase or decrease in total in direct proportion in increases or decreases in the volume of activity (Miller-Nobles et al., 2018). Thus, variable costs for Best Buy might include power, depending on how long the machines run, as well as raw materials since needs for items can fluctuate.
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?
Since the cost structure of the company is largely fixed, if the sales decrease, so will the overall operating income. The fixed costs will remain the same while the income will decline, and therefore, the operating income decreases.
Yes, having a cost structure that is largely fixed does increase the financial risk to the company. If sales decreases, those fixed costs must still be accounted for. If the company does not make sales, the operating income will suffer and the company could be put in a very poor financial position.
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?
Advertising expenses are considered fixed because they do not vary when there is a change in the sales volume (Miller-Nobles et al., 2018). If the company has a small margin of safety, or cushion between profit and loss, then increasing a fixed cost, such as advertising, can cause a decrease to the company’s overall operating income especially if sales were to decrease. If the company were to decrease advertising costs, there would be less fixed costs, and therefore, the operating income would increase. If sales were to decline, the company’s overall operating income would not be as negatively impacted.
References:
Miller-Nobles, T., Mattison, B., & Matsumura, E. M. (2018). Horngren’s Financial & Managerial Accounting (6th ed.). Pearson.
