Question

The GIANT Company consists of three divisions – Bicycle, Boats, and Skis – that are overseen by the corporate office. The Bicycle division manufactures and sells three types of bicycles: dirt bikes, mountain bikes, and racing bikes. Data on sales and expenses for the past quarter for the Bicycle Division are as follows:

	Dirt	Mountain	Racing
	Bikes	Bikes	Bikes		Total
Sales	$150,000	$220,000	110,000		$480,000
Less Variable manufacturing and
selling expenses	45,000	88,000	27,500		160,500
Contribution Margin	105,000	132,000	82,500		319,500
Less Fixed Expenses:
Bicycle Division Manager's Salary	18,750	27,500	13,750		60,000
Production line supervisors*	30,000	37,500	50,000		117,500
Depreciation of expensive special              equipment used to make each bike**	6,200	9,000	7,800		23,000
Shared production fixed expenses***	8,000	8,000	8,000		24,000
Traceable advertising for each bicycle	10,000	14,000	6,000		30,000
Allocated Head Office expenses	7,000	11,900	6,000		24,900
Total Fixed Expenses	79,950	107,900	91,550		279,400
Operating income (loss)	$25,050	$24,100	($9,050)		$40,100
*Each production line supervisor is dedicated to the production of a specific model.
**Each bike has its own special equipment dedicated to its production. *** Relate to the production of all three types of bikes

Required:

1. Management is concerned about the continued losses shown by the racing bikes line and wants a recommendation as to whether or not it should be discontinued. By how much will operating income change if management decides to drop the racing bikes product line? Clearly show/explain your work as to how you arrived at your answer and your recommendation.
2. The Divisional General Manager wants to spend another $20,000 on advertising and expects that sales will increase by 20% regardless of the product line chosen. Which of the three products should management spend the additional advertising on? Should they incur the additional advertising? By how much will profits change?

Answer 1

Change in Operating income:

Sales	110,000
Less: relevant Costs
Variable manufacturing and Selling Expenses	27,500
Contribution Margin	82,500
Less: Fixed Expenses
Bicycle Division Manager's Salary	13,750
Production line supervisors*	50,000
Depreciation (Sunk Cost)	-
Shares Production Expenses (Not relevant)	-
Traceable advertising for each bicycle	6,000
Allocated Expenses	-
Total Fixed Expenses	69,750
Operating Income (Loss)	12,750

Hence, dropping product line will lead to a drop in profits by $12,750

The advertising should be done on the product which provides the maximum contribution margin

Since fixed costs will remain the same

Increase in Contribution Margin:

Dirt Bikes = 105,000*20% = $21,000

Mountain Bikes = 132,000*20% = $26,400

Racing Bikes = 82,500*20% = 16,500

Hence, additional advertising should be done on Mountain Bikes

Yes, advertising should be done

Increase in profits = 26,400-20,000 = $6,400