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	$	240,000		$	292,000
Variable costs:
Cost of goods sold		78,000			146,000
Selling & administrative		18,000			58,000
Contribution margin	$	144,000		$	88,000
Fixed expenses:
Fixed corporate costs		68,000			83,000
Fixed selling and administrative		20,000			29,000
Total fixed expenses	$	88,000		$	112,000
Operating income	$	56,000		$	(24,000	)

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 $51,500? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).)

Answer 1

T-1 T-2

sales $240,000 $292,000

less variable cost of goods sold   $ 78,000 $146,000

varaible selling and administrative $18,000 $58,000

contribution margin $144,000 $ $88,000

contribution margin ratio=contribution margin/sales 144,000/240000 88,000/292,000

= 60% 30.13%

incremental contribution margin from T-1 if T-2 is dropped

(144000*10%) 14,400

net effect of discounting rate T-2 (14,400-88,000) (73600)

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

loss of contribution margin T-2=gain of contribution margin T-1

88,000 = 144,000*X%

X=88,000/144,000

= 61.11%

3 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 $51,500

loss of contribution margin T-2= gain in contribution margin T-1

88,000-51500 = 144,000*x%

x = 36500/144000

=25.34%