Question

Capital Toys’ management is considering eliminating product A, which has been showing a loss for several years. The company’s annual income statement, in $000s, is as follows

	A	B	C	Total
Sales Revenue	$ 2,200.00	$ 1,400.00	$ 1,800.00	$ 5,400.00
Variable expenses	$ 1,650.00	$     600.00	$ 1,080.00	$ 3,330.00
Contribution margin	$     550.00	$     800.00	$     720.00	$ 2,070.00
Advertising expense	$     500.00	$     475.00	$     720.00	$ 1,695.00
Depreciation expense	15	10	20	45
Corporate expenses	90	80	105	275
Total fixed expenses	$     605.00	$     565.00	$     645.00	$ 1,815.00
Operating income	$     (55.00)	$     235.00	$        75.00	$     255.00

a.Restate the income statement in segment margin format.

b. What would be the effect on income if product A were dropped?

c. Management is considering making a new product using product A’s equipment. If the new product’s selling price per unit were $12, its variable costs were $8, and its advertising costs were the same as for product A, how many units of the new product would the company have to sell to make the switch from product A to the new product worthwhile?

Answer 1

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Part a
			A	B	C	Total
Sales Revenue			$    2,200	$    1,400	$    1,800	$    5,400
Less: Cost of goods sold			$   -1,650	$      -600	$   -1,080	$   -3,330
Contribution Margin			$       550	$       800	$       720	$    2,070
Less: Direct Fixed Cost
Advertising			$      -500	$      -475	$      -520	$   -1,495
Depreciation			$        -15	$        -10	$        -20	$        -45
Segment Margin			$         35	$       315	$       180	$       530
less: Common fixed Expense						$      -275
Operating Profit						$       255
Part b
Because of dropping product A, income will come down by $50,000 ($550,000-$500,000). Depreciation is unavoidable expense.
Part c
Contribution margin for New product	$12-$8	$               4	a
New Product must generate minimm Margin		$   550,000	b
Units Needed		137,500