Question

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

Segmented Income Statement from MSI's ToddleTown Tours Product Lines	Pet Store Parade	Grocery Getaway	Post Office Polka	Total
Sales Revenue	$80,000	$75,000	$25,000	$180,000
Variable Costs	$35,000	$31,000	$20,000	$86,000
Contribution Margin	$45,000	$44,000	$5,000	$94,000
Less; Direct Fixed Costs	$6,000	$4,900	$4,700	$15,6000
Segment Margin	$39,000	$39,100	300	$78,400
Less: Common Fixed Costs*	$12,000	$11,250	$3,750	$27,000
Net Operating Fixed Income (Loss)	$27,000	$27,850	($3,450)	$51,400

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.

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 $3,000 of the common fixed costs could be avoided if the POP product line were eliminated.

3-b. Should MSI drop the POP product? Yes No

Please explain how you got those numbers.

Answer 1

1. Income statement

	Pet store ($)	Grocery Getaway ($)	POP	Total ($)
Sales revenue	80,000	75,000		155,000
Variable cost	35,000	31,000		66,000
Contribution margin	45,000	44,000		89,000
Direct fixed costs	6,000	4,900	4,700	15,600
Common fixed costs	12,000	11,250	3,750	27,000
Net operating income	27,000	27,850	(8,450)	46,400

Hence, if POP is eliminated, total profits of MSI will drop from $51,400 to $46,400.

2.

Since by dropping the POP product, total profits of MSI will fall from $51,400 to $46,400, hence POP product should not be eliminated.

3a

Income statement

	Pet store ($)	Grocery Getaway ($)	POP	Total ($)
Sales revenue	80,000	75,000		155,000
Variable cost	35,000	31,000		66,000
Contribution margin	45,000	44,000		89,000
Direct fixed costs	6,000	4,900	4,700	15,600
Common fixed costs	12,000	11,250	750	24,000
Net operating income	27,000	27,850	(5,450)	49,400

Hence, if POP is eliminated, total profits of MSI will drop from $51,400 to $49,400.

3b.

Since by dropping the POP product, total profits of MSI will fall from $51,400 to $49,400, hence POP product should not be eliminated.

POP was generating a contribution margin of $5,000. Hence as long as fixed costs do not reduce by more than $5,000, it would not be profitable to eliminate POP.