Question: Denver Furniture Corp. is nationally recognized for making high-quality products. Management is concerned that the company is not fully exploiting its brand power. Denver'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. Also, it could 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:
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(In thousands)
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Current Results
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Proposed Results without Cannibalization
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Proposed Results with Cannibalization
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|
Sales Revenue
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$45,000
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$60,000
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$50,000
|
|
Net Income
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$12,000
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$13,000
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$12,000
|
|
Average total assets
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$100,000
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$100,000
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$100,000
|
Instructions: A) Compute Denver's return on assets, profit margin, and asset turnover; both with and without the new product line.
B) Discuss the implications that your findings in part (a) have Denver's decision.
C) Are there any other options that Denver should consider? What impact would each of these have on the above ratios?