Question

The following information is for X Company's two products - A and B:

	Product A	Product B
Sales	$93,000	$90,000
Total contribution margin	40,920	36,000
Fixed costs:
Avoidable	24,000	30,500
Unavoidable	7,000	26,000
Profit	$9,920	$-20,500

The company is considering dropping Product B because of the $20,500 loss. If X Company drops Product B, it can use the freed-up resources to increase sales of Product A by $13,000. If X Company drops Product B and increases sales of A by $13,000, firm profits will change by?

A: $117

B: $137

C: $161

D: $188

E: $220

F: $257

Answer 1

Answer: Option E $ 220

Calculation of change in firm profit is as follows:

Change in firm profit = loss after drops of Product B - loss prior to drops of Product B

= $ 10,360 - $ 10,580

= $ 220

Earlier loss was $ 10,580. After drop of product B loss is $ 10,360. Decrease in loss is $ 220 ( $ 10,580 -$ 10,360 ). We can say that increase in profit by $ 220

Thus, Answer is option E $ 220. Increase in profit by $ 220.

Working note:

1. Calculation of Profit/loss prior to drops of Product B:

Profit / ( loss) prior to drops of Product B = Profit /(loss) of Product A + Profit /(loss) of Product B

= $ 9,920 + ( $ 20,500)

= ($ 10,580)

Thus, Loss prior to drop of Product B is $ 10,580

2. Calculation of Profit/loss after drops of Product B:

Profit/loss after drops of Product B = Revised contribution margin - Fixed cost

= $ 46,640 - $ 57,000

= ( $ 10,360 )

Thus, After drop of Product B firm loss is $ 10,360

Calculation of Revised contribution margin:

Increase sales of Product A by $13,000

Revised contribution margin = Revised Sales * Contribution margin ratio

= $ 106,000 * 44%

= $ 46,640

Revised Sales = $ 93,000 + $ 13,000

= $ 106,000

Contribution margin ratio = ( Contribution margin / Sales ) * 100

= ( $ 40,920 / $ 93,000 ) * 100

= 44%

Calculation of Fixed cost:

Avoidable Fixed cost of B is associated with product B production means if Product B discontinues then fixed cost also not incurred.However, Unavoidable fixed cost is not avoidable even if Product B discontinued.

Therefore Unavoidable cost will absorbed by Product A

Fixed cost = Avoidable cost of A + Total unavoidable cost

= $ 24,000 + ( $ 7,000 + $ 26,000 )

= $ 57,000