Chapter 2, Problem 12P

Lemon Auto Wholesalers had sales of $\text{\$1,000,000}$ last year, and cost of goods sold represented 78 percent of sales. Selling and administrative expenses were 12 percent of sales. Depreciation expense was $\text{\$11,000}$ and interest expense for the year was $\text{\$8,000}$ . The firm’s tax rate is 30 percent.

a. Compute earnings after taxes.

b. Assume the firm hires Ms. Carr, an efficiency expert, as a consultant. She suggests that by increasing selling and administrative expenses to 14 percent of sales, sales can be increased to $\text{\$1,050,900}$ . The extra sales effort will also reduce cost of goods sold to 74 percent of sales. (There will be a larger markup in prices as a result of more aggressive selling.) Depreciation expense will remain at $\text{\$11,000}$ . However, more automobiles will have to be carried in inventory to satisfy customers, and interest expense will go up to $\text{\$15,800}$ . The firm’s tax rate will remain at 30 percent. Compute revised earnings after taxes based on Ms. Carr’s suggestions for Lemon Auto Wholesalers. Will her ideas increase or decrease profitability?