Answer to Question #225855 in Finance for Anisha Radhika Kum

Question

Dan Levy is in partnership with three others in their business, Outdoor Camping World. (Outdoor World had been Dan’s business and Camping World had been run by the other three until they merged the businesses last year. They merged the names too, so they might keep all their old customers, even though it doesn’t make much sense.) Dan argues that the firm should maximise gross profit margins [(selling price – buying price)/ selling price] on each item of stock. (a) Do you think this is a valid financial objective? (b) Is this objective consistent with maximisation of partners’ wealth? (c) What problems do you see in operationalising this objective?

Answer 1

• This is not a valid objective as these partners are not aware if by raising the marginal cost will retain their customers or not.
• The objective is not consistent with the partners wealth as the company is not fit to control the overhead costs and it is not guaranteed whether their customers will be willing to pay more to maintain their higher than before gross profit.
• The major problem in this objective is that the ability to earn high gross margin is not in their control and it may fail at some point.
• If they do not sell enough, they will encounter loss that will offset their profits somewhere else i.e paying of bills