Decision Whether to Close a Store
Power Music owns five music stores, where it sells music, instruments, and supplies. In addition, it rents instruments. At the end of last year, the new accounts showed that although the business as a whole was profit table, the Fifth Avenue store had shown a substantial loss. The income statement for the Fifth Avenue store for last month follows:
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POWER MUSIC Fifth Avenue Store Partial Income Statement |
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Sales |
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$650,000 |
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Cost of goods sold |
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560,000 |
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Gross margin |
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$ 90,000 |
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Costs: |
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Payroll, direct labor, and supervisiona |
$ 51,000 |
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Rentb |
16,100 |
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State taxesc |
2,500 |
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Insurance on inventory |
18,400 |
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Depreciationd |
7,500 |
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Administration and general officee |
20,000 |
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Interest for inventory carrying costsf |
4,500 |
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Total costs |
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120,000 |
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Loss |
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$ (30,000) |
Additional computations:
aThese costs would be saved if the store was closed.
bThe rent would be saved if the store was closed.
cAssessed annually on the basis of average inventory on hand each month.
d8.5 percent of cost of departmental equipment. The equipment has no salvage value, and
Power Music would incur no costs in scrapping it.
eAllocated on the basis of store sales as a fraction of total company sales. Management estimates that 10% of these costs allocated to the Fifth Avenue store could be saved if the store was closed.
fBased on average inventory quantity multiplied by the company’s borrowing rate for three month loans.
Analysis of these results has led management to consider closing the Fifth Avenue store. Members of the management team agree that keeping the Fifth Avenue store open is not essential to maintaining good customer relations and supporting the rest of the company’s business. In other words, eliminating the Fifth Avenue store is not expected to affect the amount of business done by the other stores.
Required
What action do you recommend to Power Music’s management? Write a short report to management recommending whether or not to close the Fifth Avenue store. Include the reasons for your recommendation.