1. Evaluate the projected income statement for Hollydazzle presented in Exhibit 2.

Is this income
statement appropriate for projecting profitability? Why or why not?

The issue with this income statement is that Site Maintenance is not calculated in the Cost of Goods
Sold. This cost is Hollydazzles equivalent of their store rent. Adding this lowers their Gross Profit
estimates.
In addition, when making the decision to go into business, they need to also consider the Opportunity
Costs involved. Their Opportunity Costs are $375,000 plus the value of the benefits they would also
earn. These would not be seen on their Income Statement, but they are relevant as a part of their
decision process.

2.
a. Forecast Hollydazzles operating income for the year ended June 30, 2000 if sales grow by 50% over
forecasted sales for the June 30, 1999 year. Assume that Hollydazzles cost structure and relationships
remain the same as in 1998, and as before, 1,200 new customers make purchases each month.

At a 50% growth, Hollydazzles operating income would be a $113,824.00 loss at the end of 2000.

b. Do you agree with Johns analysis that increased volume will improve Hollydazzles profitability?
Provide some analysis to support your answer.

Yes, Jon is correct that increased volume will improve Hollydazzles profitability. However, it is
important to recognize that at maximum capacity (300,000), their operating income is only $57,176.00.
(This, divided by the three partners, is only $19,060 as opposed to the $125,000 plus benefits that they
could be making otherwise.

3. Holldazzle can also consider outsourcing its warehousing and distribution functions. It would have to
pay MooV, a warehousing and distribution specialist who has worked with other E-tailers, 6% of total
sales. Should Hollydazzle consider outsourcing its warehouse operations? At what level of sales would
it be indifferent between insourcing and outsourcing? What other factors should Kristin, Eric and John
consider in making a decision?

Hollydazzle should consider outsourcing at their present level of estimated sales. Their savings would be
$3,360. This depends on a variety of things, though. This is dependant on MooV providing a yearly
contract only because, at the estimated growth rate, Hollydazzle would be better off not outsourcing
once their number of transactions reached greater than 54,054. It also depends on the value of
experience in the warehousing and distribution field will assist the team as they move forward with the
business.

4. John and Eric are keen to generate additional revenues for their business by getting e-tailers of
complementary products to advertise on Hollydazzles website. Kristin immediately set about allocating
costs in order to analyze the relative profitability of the merchandising and advertising parts of
Holydazzles business. Which costs, if any, do you suggest she should try to allocate, and why? (Note:
This is more of a conceptual question about whether/why Kristin should go to the trouble to allocate
shared or common costs to the different lines of business). Why should she, or shouldnt she?

She should definitely go through the trouble to allocate the shared / common costs by complementary
products. These numbers will be very useful as the business moves forward to analyze the success
and/or failure of certain products. If these products struggle, then Hollydazzle will be able to make an
educated decision about the profitability of dropping a product line.

5. For the year ended June 30, 1999, Hollydazzles actual performance was as follows: It had 50,000
transactions and revenues of $450,000. Actual average merchandise costs per transaction were $8.75.
Based on this information, what was the companys actual gross margin? What factors explain the
difference between actual and budgeted gross margin (be as specific as possible)? Based on this
analysis, what actions should managers take to get their actual profit on track with expectations?

The companys actual gross margin was -$53,500, or a unit cost of $-1.07. The reason for this was
because their differential between unit sales and unit merchandise cost (variable) is only $ 0.25.
Therefore, in order to overcome the $66,000 cost of goods sold, they would need 264,000 transactions.
The managers should increase their prices, reduce their fixed costs, reduce their variable costs, or
remove the lower-margin products that are bringing their average unit revenue down.

6. Do you think that Kristin, Eric and John should move forward with this business venture? If so, what
three key performance indicators should they focus on to ensure their companys future success? If not,
what lessons can we learn from their experience trying to launch an internet based business?

I do not think that they should move forward with the business. The opportunity cost is too high and
they will never recover these costs without changes to their business structure. **need lessons
learned**