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 $ 245,000 $ 296,000 Variable costs: Cost of goods sold 79,000 148,000 Selling & administrative 19,000 59,000 Contribution margin $ 147,000 $ 89,000 Fixed expenses: Fixed corporate costs 69,000 84,000 Fixed selling and administrative 21,000 30,000 Total fixed expenses $ 90,000 $ 114,000 Operating income $ 57,000 $ (25,000 ) 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 $53,000? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).)

Answer 1

Answer:

1. Find the expected change in annual operating income by dropping T-2 and selling only T-1.

	T1	T2
Sales	245,000	296,000
Less: Variable cost of goods sold	79,000	148,000
Variable selling and administration	19,000	59,000
Contribution margin	147,000	89,000
Contribution margin ratio = Contribution margin / sales	60%	30.06%

Incremental contribution margin from t1,

T2 = 147,000*10%

T2 = 14,700

Now, Net effecting of discontinue , T2 = 89,000 - 14700

= 74,300

2) By what percentage would sales from T-1 have to increase in order to make up the financial loss from dropping T-2?

We know that,

Loss of Contribution margin T2 = Gain on contribution margin T1

89,000 = 147,000 * X%

89,000 / 147,000 = X%

Therefore,

X% = 60.5%

Hence, 60.5% sales from T1 have to increase in order to make up the financial loss from dropping T2.

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 $53,000?

We know that,

Loss of contribution margin T1 = Gain on contribution margin T1

Contribution margin-Fixed costs = Contribution margin *X%

89000 - 53,000 = 147,000 * X%

36,000 = 147,000*X%

36,000 / 147,000 = X%

Therefore,

X% = 24.48%.

Hence, At 24.48% sales increase from T1 to compensate for lost margin from T2.