10.4
Projecting Gross Profit: The Effects of Volume versus Price. Suppose you are analyzing a firm that is
successfully executing a strategy that differentiates its products from those of its competitors. Because
of this strategy, you project that next year the firm will generate 6.0 Percent revenue growth from price
increases and 3.0 percent revenue growth from sales volume increases. Assume that the firm’s
production cost structure involves strictly variable costs. (That is, the cost to produce each unit of
product remains the same.) Should you project that the firm’s gross profit will increase next year? If you
project that the gross profit will increase, is the increase a result of volume growth, price growth, or
both? Should you project that the firm’s gross profit margin (gross profit divided by sales) will increase
next year? If you project that the gross profit margin will increase, is the increase a result of volume
growth price growth, or both?
Answer:
The drivers of different components of revenue growth have different effect on gross profit and gross
profit margin. Both the factors drive the cost up. Only increase in price drives up the gross profit margin
because it considers the variable production costs. Hence, cost of goods sold is a variable cost per unit,
therefore the volume increases with the proportional increase in cost of goods sold. However, price
increases do not cause the increase in costs.
10.9
Store-Driven Forecasts. The Home Depot is a leading specialty retailer of hardware and home
improvement products and is the second-largest retail store chain in the United States. It operates large
warehouse-style stores. Despite declining sales and difficult economic conditions in 2007 and 2008. The
Home Depot continued to invest in new stores. The following table provides summary data for The
Home Depot.
The Home Depot (amounts in 2007 2008
millions except number of
stores)
Number of Stores 2,234 2,274
Sales Revenues $77,349 $71,288
Inventory $11,731 $10,673
Capital Expenditures, net $3,558 $1,847
Required
a. Use the preceding data for The Home Depot to compute average revenues per store, capital
spending per new store, and ending inventory per store in 2008.
b. Assume that The Home Depot will add 100 new stores by the end of Year +1. Use the data from
2008 to project Year +1 sales, revenues, capital spending, and ending inventory. Assume that
each new store will be open for business for an average of one-half year in Year +1. For
simplicity, assume that in Year +1, Home Depot’s sales revenues will grow, but only because it
will open new stores.
Projecting Gross Profit: The Effects of Volume versus Price. Suppose you are analyzing a firm that is
successfully executing a strategy that differentiates its products from those of its competitors. Because
of this strategy, you project that next year the firm will generate 6.0 Percent revenue growth from price
increases and 3.0 percent revenue growth from sales volume increases. Assume that the firm’s
production cost structure involves strictly variable costs. (That is, the cost to produce each unit of
product remains the same.) Should you project that the firm’s gross profit will increase next year? If you
project that the gross profit will increase, is the increase a result of volume growth, price growth, or
both? Should you project that the firm’s gross profit margin (gross profit divided by sales) will increase
next year? If you project that the gross profit margin will increase, is the increase a result of volume
growth price growth, or both?
Answer:
The drivers of different components of revenue growth have different effect on gross profit and gross
profit margin. Both the factors drive the cost up. Only increase in price drives up the gross profit margin
because it considers the variable production costs. Hence, cost of goods sold is a variable cost per unit,
therefore the volume increases with the proportional increase in cost of goods sold. However, price
increases do not cause the increase in costs.
10.9
Store-Driven Forecasts. The Home Depot is a leading specialty retailer of hardware and home
improvement products and is the second-largest retail store chain in the United States. It operates large
warehouse-style stores. Despite declining sales and difficult economic conditions in 2007 and 2008. The
Home Depot continued to invest in new stores. The following table provides summary data for The
Home Depot.
The Home Depot (amounts in 2007 2008
millions except number of
stores)
Number of Stores 2,234 2,274
Sales Revenues $77,349 $71,288
Inventory $11,731 $10,673
Capital Expenditures, net $3,558 $1,847
Required
a. Use the preceding data for The Home Depot to compute average revenues per store, capital
spending per new store, and ending inventory per store in 2008.
b. Assume that The Home Depot will add 100 new stores by the end of Year +1. Use the data from
2008 to project Year +1 sales, revenues, capital spending, and ending inventory. Assume that
each new store will be open for business for an average of one-half year in Year +1. For
simplicity, assume that in Year +1, Home Depot’s sales revenues will grow, but only because it
will open new stores.
