how much would sales have to drop under the status quo strategy for the two strategi 546322

Gillette Inc., the leading producer of grooming aids, was faced with a significant corporate strategy decision early in 1994 on whether it would continue its high-margin strategy or shift to a lower margin strategy to increase sales revenues in the face of intense generic competition. The two strategies are being considered.

Status Quo High-Margin Strategy

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* Maintain profit margins at 1993 levels (In 1993, net income was $575 million on revenues of $5,750 million.) from 1994 to 2003.

* The sales/book value ratio, which was 3 in 1993, can then be expected to decline to 2.5 between 1994 and 2003.

* Reduce net profit margin to 8% from 1994 to 2003.

* The sales/book value ratio will then stay at 1993 levels from 1994 to 2003.

The book value per share at the end of 1993 is $9.75. The dividend payout ratio, which was 33% in 1993, is expected to remain unchanged from 1994 to 2003 under either strategy, as is the beta, which was 1.30 in 1993. (The T.Bond rate is 7%) After 2003, the earnings growth rate is expected to drop to 6% and the dividend payout ratio is expected to be 60% under either strategy. The beta will decline to 1.0.

a. Estimate the price/sales ratio under the status quo strategy.

b. Estimate the price/sales ratio under the low margin strategy.

c. Which strategy would you recommend and why.

d. How much would sales have to drop under the status quo strategy for the two strategies to be equivalent?

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