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	$	285,000		$	328,000
Variable costs:
Cost of goods sold		87,000			164,000
Selling & administrative		27,000			67,000
Contribution margin	$	171,000		$	97,000
Fixed expenses:
Fixed corporate costs		77,000			92,000
Fixed selling and administrative		29,000			38,000
Total fixed expenses	$	106,000		$	130,000
Operating income	$	65,000		$	(33,000	)

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 $54,000? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).)

	1. 2. Required % increase in sales of T-1 % 3. Required % increase in sales from T-1 %

Answer 1

(1) we wont consider fixed cost as they are not relevant for the decision as they are fixed irrespective of whether T2 is continued or not.

we will compare contribution margin

PRODUCT T-1

CONTRIBUTION MARGIN RATIO = CONTRIBUTION MARGIN / SALES   =171000/285000         =   60%

Incremental sales if T-2 is dropped = 285000*10% =$28500

Incremental contribution margin = 28500*60% =$17100

PRODUCT T -2

CONTRIBUTION MARGIN LOST IF T-2 IS DROPPED= $97000

CHANGE IN ANNUAL OPERATING INCOME = $17100Increase in contribution margin of T-1 - $97000 Decrease in contribution margin of T-2

REDUCTION IN OPERATING INCOME=($79900)

[2]Increase in sales for T-1 to earn $97000 contribution margin.

contribution expected/ contribution margin ratio

=97000/ 60%

Increase in sales = $161667

=161667 / 285000

56.72% increase from current sales.

CHECK

TOTAL SALES = 285000+161667= 446667

contribution = 446667*60% = $268000 which is same as last year contribution margin of T1 & T2 [171000+97000]

[3]Loss of contribution margin from T2 = $97000- $54000 SAVED =$43000

contribution expected/ contribution margin ratio

43000/60%

=$71667 INCREASE IN SALES REQUIRED

71667/285000

=25.15%