Question

Morning Sky, Inc. (MSI), manufactures and sells computer games. The company has several product lines based on the age range of the target market. MSI sells both individual games as well as packaged sets. All games are in CD format, and some utilize accessories such as steering wheels, electronic tablets, and hand controls. To date, MSI has developed and manufactured all the CDs itself as well as the accessories and packaging for all of its products.

The gaming market has traditionally been targeted at teenagers and young adults; however, the increasing affordability of computers and the incorporation of computer activities into junior high and elementary school curriculums has led to a significant increase in sales to younger children. MSI has always included games for younger children but now wants to expand its business to capitalize on changes in the industry. The company currently has excess capacity and is investigating several possible ways to improve profitability.

MSI is considering eliminating a product from its ToddleTown Tours collection. This collection is aimed at children one to three years of age and includes “tours” of a hypothetical town. Two products, The Pet Store Parade and The Grocery Getaway, have impressive sales. However, sales for the third CD in the collection, The Post Office Polka, have lagged the others. Several other CDs are planned for this collection, but none is ready for production.

MSI’s information related to the ToddleTown Tours collection follows:

Segmented Income Statement for MSI’s
ToddleTown Tours Product Lines
	Pet Store Parade			Grocery Getaway			Post Office Polka				Total
Sales revenue	$	135,000		$	130,000		$	36,000			$	301,000
Variable costs		57,000			53,000			32,000				142,000
Contribution margin	$	78,000		$	77,000		$	4,000			$	159,000
Less: Direct Fixed costs		8,200			8,200			3,400				19,800
Segment margin	$	69,800		$	68,800		$	600			$	139,200
Less: Common fixed costs*		6,750			6,500			1,800				15,050
Net operating income (loss)	$	63,050		$	62,300		$	(1,200	)		$	124,150

      
*Allocated based on total sales dollars.

MSI has determined that elimination of the Post Office Polka (POP) program would not impact sales of the other two items. The remaining fixed overhead currently allocated to the POP product would be redistributed to the remaining two products.

Required:
1. Calculate the incremental effect on profit if the POP product is eliminated.

Effect On Profit

2. Should MSI drop the POP product?

	Yes
	No

3-a. Calculate the incremental effect on profit if the POP product is eliminated. Suppose that $1,200 of the common fixed costs could be avoided if the POP product line were eliminated.

Effect On Profit

3-b. Should MSI drop the POP product?

	Yes
	No

Answer 1

1. Calculate the incremental effect on profit if the POP product is eliminated.

The incremental effect on profit if the POP product is eliminated.will be decrease by $600

Calculation the incremental effect on profit if the POP product is eliminated.

New Net operating income after elimination of POP Store= Net Operating Income from Pet Store +Net Operating Income from Grocery Getaway - Common cost of POP store now to be allocated to Pet Store and Grocery Gateway

New Total Net Operating Income = $63050+$62300 -$600

New Total Net Operating Income = $123550

Old Net Operating income = $ 124150

Net Effect = $124150-$123550

Net Effect = $600 decrease

Requirement 2 Should MSI drop the POP product

NO

MSI should not drop the POP product as it would result in reduction of overal net operating income of the MSI by $600 as calculated in Requirement 1

3-a. Calculate the incremental effect on profit if the POP product is eliminated. Suppose that $1,200 of the common fixed costs could be avoided if the POP product line were eliminated.

The incremental effect on profit if the POP product is eliminated.will be increase by $600

Calculation the incremental effect on profit if the POP product is eliminated.

New Net operating income after elimination of POP Store= Net Operating Income from Pet Store +Net Operating Income from Grocery Getaway - Common cost of POP store now to be allocated to Pet Store and Grocery Gateway

New Total Net Operating Income = $63050+$62300 -$600($1800-$1200)

New Total Net Operating Income = $124750

Old Net Operating income = $ 124150

Net Effect = $124750-$124150

Net Effect = $600 increase

3-b. Should MSI drop the POP product?

Yes

MSI should drop the POP product as it would result in increase in  overall net operating income of the MSI by $600 as calculated in Requirement 2

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THANK YOU