Problem:
Chicago Electronics offers a six-month warranty on the products it sells. It estimates the warranty expense will be 3 percent of sales. One of the company managers wondered how the warranty affects the company's profit. The income statement for the most recent year was:
Sales $18,000,000
Cost of goods sold 11,700,000
Gross margin 6,300,000
Warranty expense 540,000
Other selling and administrative expenses 4,800,000
Net income $960,000
The manager estimates that if the company did not offer the warranty, sales and cost of goods sold would both decrease by 30 percent and selling and administrative expenses would decrease by 20 percent. Based on this information, would you recommend that the company discontinue the warranty? Prepare an income statement to support your answer. Evaluate this company based on this information.