Question

Barbour Corporation, located in Buffalo, New York, is a retailer of high-tech products and is known for its excellent quality and innovation. Recently, the firm conducted a relevant cost analysis of one of its product lines that has only two products, T-1 and T-2. The sales for T-2 are decreasing and the purchase costs are increasing. The firm might drop T-2 and sell only T-1. Barbour allocates fixed costs to products on the basis of sales revenue. When the president of Barbour saw the income statements (see below), he agreed that T-2 should be dropped. If T-2 is dropped, sales of T-1 are expected to increase by 10% next year, but the firm’s cost structure will remain the same. T-1 T-2 Sales $ 280,000 $ 324,000 Variable costs: Cost of goods sold 86,000 162,000 Selling & administrative 12,000 66,000 Contribution margin $ 182,000 $ 96,000 Fixed expenses: Fixed corporate costs 76,000 91,000 Fixed selling and administrative 28,000 37,000 Total fixed expenses $ 104,000 $ 128,000 Operating income $ 78,000 $ (32,000 ) Required: 1. Find the expected change in annual operating income by dropping T-2 and selling only T-1. 2. By what percentage would sales from T-1 have to increase in order to make up the financial loss from dropping T-2? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).) 3. What is the required percentage increase in sales from T-1 to compensate for lost margin from T-2, if total fixed costs can be reduced by $52,500? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).)

Answer 1

Existing
Particulars	T-1	T-2	Total	Percentage of variable cost to sales of T-1
Sales	280,000	324,000	604,000
Variable cost (Cost of goods sold)	86,000	162,000	248,000	30.7143%
Variable cost (Selling and Admin)	12,000	66,000	78,000	4.285%
Contribution	182,000	96,000	278,000
Fixed cost (corporate cost)	76,000	91,000	167,000
Fixed cost (Selling and Admin)	28,000	37,000	65,000
Operating income	78,000	-32,000	46,000

1.Change in annual operating income
Particulars	T-1	Remarks
Sales	308,000	280000 + 10% of 280000
Variable cost (Cost of goods sold)	94,600	30.714 % of Sales
Variable cost (Selling and Admin)	13,200	4.285 % of Sales
Contribution	200,200
Fixed cost (corporate cost)+ (Selling and Admin)	232,000	167,000 + 65,000
Operating income	-31,800

Financial loss on dropping T-2 = 31,800

Contribution has to increase by 31,800 to make up the loss from dropping T-2

Target Contribution = 232,000 (200,200+31,800)

Sales required to achieve target contribution = 356,923 (see note-2)

Percentage increase required to make good the loss = (356,923-280,000) / 280,000 => 27.47%

Notes-

1.On dropping T-2, sales of T-1 would increase by 10%, the cost structure would not change. Hence the variable cost is computed at same percentage of sales as done previously

2.Computation of sales required to achieve target contribution (cross multiplying to achieve the desired figures)

Particulars	Percentage		Amount
Sales	100%	?	356,923
COGS	30.714%	?	109,627
S & A	4.286%	?	15,296
Contribution	65%	232,000	232,000

3.Change in annual operating income (Reduction in Fixed cost)
Particulars	T-1
Sales	308,000
Variable cost (Cost of goods sold)	94,600
Variable cost (Selling and Admin)	13,200
Contribution	200,200
Fixed cost (corporate cost)+ (Selling and Admin)	179,500
Operating income	20,700

Margin lost on discontinuance of T-2 = 96,000 (see the old income statement)

To make the operating income as 96,000 from sale of T-1 the contribtion should increase by 75,300 (96,000-20,700)

Target contribution = 275,500 (200,200+75,300)

Sales required to achieve target contribution = 423,846 (see note-2)

Percentage increase required to compensate contribution lost from T-2 = (423,846-280,000) / 280,000 => 51.37%

Notes-

1.The Sales and Variable cost figures would be same as that of computed under question no 1 .The total fixed cost gets reduced by 52,500 from 232,000 to 179,500

2..Computation of sales required to achieve target contribution (cross multiplying to achieve the desired figures)

Particulars	Percentage		Amount
Sales	100%	?	423,846
COGS	30.714%	?	130,181
S & A	4.286%	?	18,165
Contribution	65%	275,500	275,500