Question

M7-7 Analyzing Keep-or-Drop Decision [LO 7-2, 7-5] Blowing Sand Company produces the Drafty model fan, which currently has a net loss of $50,000 as follows: Drafty Model Sales revenue $ 270,000 Less: Variable costs 189,000 Contribution margin $ 81,000 Less: Direct fixed costs 71,000 Segment margin $ 10,000 Less: Common fixed costs 60,000 Net operating income (loss) $ (50,000) Eliminating the Drafty product line would eliminate $71,000 of direct fixed costs. The $60,000 of common fixed costs would be redistributed to Blowing Sand’s remaining product lines. Will Blowing Sand’s net operating income increase or decrease if the Drafty model is eliminated? By how much?

Total Profit _________

by ________

Answer 1

Answer : Total Profit decreases by $10,000

Explanation :

	Continuing	Eliminating
Sales Revenue	$270,000	-
Less : Variable Cost	($189,000)	-
Contribution Margin	$81,000	-
Less : Direct Fixed Costs	($71,000)	-
Segment Margin	$10,000	-
Less : Common Fixed Costs	($60,000)	($60,000)
Net Operating Income (loss)	($50,000)	($60,000)

If Drafty Product line is eliminated, revenue generated will be zero and the variable cost will also be zero. Which means contribution margin will be zero.

Since, it is given that direct fixed cost of $71,000 will be elimated. It means that direct fixed cost will now be zero. Therefore, segment margin will also be zero.

But it is given that the common fixed cost of $60,000 would be redistributed to remaining product lines it means that it will still be incurred.

Therefore, the net operating loss will now be $60,000.

Old net loss = $50,000 (Given)

Increase in net loss = New Net Loss - Old Net Loss

= $60,000 - $50,000

= $10,000

Therefore, Total Profit will decrease by $10,000.

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