Chapter 1

• Natalie's Knick Knacks is a boutique store that sells seasonal merchandise.
For this Christmas season, Natalie paid $50,000 for an

order of figurines, tree ornaments, candles, and wreaths. Natalie marks up each piece of merchandise by 100% to arrive at the selling
price. Thus, if Natalie pays $20 for a figurine, she will price it at $40.

• Unfortunately, sales were well below expectations, and Natalie's revenues were only $65,000 (far less than the $100,000, or $50,000
× 2, that she had hoped for). This presents a quandary for Natalie, who is contemplating what to do with the unsold merchandise.
One option is for Natalie's to store the unsold merchandise for the next 10 months and attempt to sell it the next Christmas season.
Natalie estimates that it would cost her $4,000 to properly pack, store, and then unpack all of the unsold merchandise. In addition,
because the merchandise would be somewhat dated, Natalie believes that she will only be able to sell 30% of the remaining
merchandise the following year (at the current year's retail price). Any unsold items will have negligible resale value, and Natalie
plans to donate them to a local charity.

• Alternatively, Natalie could hold a January after-Christmas sale. Specifically, Natalie believes that she can sell 100% of the unsold
merchandise if she holds an “80% off sale,” 80% of the unsold merchandise if she holds a “70% off sale,” 55% of the unsold
merchandise if she holds a “60% off” sale, and 40% of the unsold merchandise if she holds a “50% off” sale. (The % off is the
reduction in the selling price; thus, under a 60% off sale, a figurine priced at $40 would sell for $16, or $40 - [.60 × $40]). Natalie
would donate any unsold merchandise to a local charity.

• Discussion Questions:
• a. What options does Natalie face with respect to the unsold merchandise?
• b. What is the net cash flow associated with each of Natalie's options?
• c. Based on your answer to part (b), what is the opportunity cost associated with each option?
• d. What would you recommend to Natalie?
1
Solution: Implementing the four-step
framework
a) Natalie’s decision problem centers on what to do
with the unsold merchandise. Natalie’s goal is to
maximize her profit. For the unsold merchandise, this
means maximizing the revenues received from selling
the merchandise less any additional costs associated
with selling the merchandise. The amount that
Natalie paid for the unsold merchandise, or
($100,000 – $65,000) × .50 = $17,500 is cost incurred
in the past and therefore is not relevant to Natalie’s
decision at hand.
2
framework
b) Based on the information provided, Natalie
has 5 options:
1. Store the unsold merchandise for 10 months
and attempt to sell it next season.
2. Hold an 80% off sale.
3. Hold a 70% off sale.
3
framework
C) First, find out how much merchandise remain
unsold. Dollar value of unsold merchandise =
$100,000 – $65,000 = $35,000
The increase in Natalie’s cash flow under option (1) is
given below:
1. Store and Sell Next
Year:
Revenue next year ($35,000)  .30 $10,500
Packing and storage (4,000)
costs
Increase in cash flow $6,500
4
framework
• The increase in cash flow from options (2) through (5) are given below:
Hold January after-Christmas Sale
Option 2 Option 3. Option 4 Option 5.
80% off 70% off sale 60% off 50% off sale
sale sale
Value of unsold merchandise at original price
$35,000 $35,000 $35,000 $35,000
Discount =
% off  $35,000 28,000 24,500 21,000 17,500

Expected revenues at discounted price if all
merchandise is sold $7,000 $10,500 $14,000 $17,500
% of merchandise expected to be sold @ the
discounted price 100% 80% 55% 40%
Value of the option = Revenue from the sale (i.e. $7,000 $8,400 $7,700 $7,000
Increase in Cash flow)
5
framework
d) Given the available options, we find that Natalie’s best
strategy is to hold a “70% off” sale. This strategy nets
Natalie $700 more than the next-best option, which is
the 60% off sale. Moreover, this option is the only one
whose value exceeds its opportunity cost.
In fact, we can go beyond the problem and suggest to
Natalie another strategy that is better than the
strategies that Natalie is currently considering. I would
call this strategy “sequential strategy”. If Natalie
follows this strategy, she can expect to generate a
revenue of $13,125 which is $4,725 more than option
(3) above. The details of this strategy are given in the
next slide.
6
framework
• Details of the “sequential strategy”
Sequential Strategy Detail Revenues
50% off $35,000  .50  .40 $7,000
60% off $35,000  .40  .15* 2,100
70% off $35,000  .30  .25** 2,625
80% off $35,000  .20  .20*** 1,400
Expected Revenues $13,125
• *0.55 – 0.40 = 0.15
• **0.80 – 0.55 = 0.25
• ***1.0 – 0.8 = 0.2

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• Natalie's Knick Knacks is a boutique store that sells seasonal merchandise.

For this Christmas season, Natalie paid $50,000 for an

% off  $35,000 28,000 24,500 21,000 17,500

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