Question

In: Accounting

Michael’s Bicycles manufactures different types of bicycles: mountain, road, and youth. Sales of the road bikes...

Michael’s Bicycles manufactures different types of bicycles: mountain, road, and youth. Sales of the road bikes have fallen. The firm is considering two options:

(1) drop the road bike line; or

(2) replace the road bike line with fat tire bikes.

Price and cost data are as follows:

Mountain

Road

Youth

Fat Tire

Price/unit

$400

$1200

$120

$600

Variable cost/unit

$300

$600

$75

$400

Total Fixed costs

$3,000,000

$2,500,000

$500,000

$1,000,000

Number of units

15,000

4,000

20,000

10,000


If the road bike line is dropped, 60% of the $2,500,000 fixed cost is avoidable.

Required:

a)         Calculate the increase or decrease on operating income, using relevant amounts only, for option 1. Be sure to indicate if the operating profits increase or decrease.

b)         Calculate the increase or decrease on operating income, using relevant amounts only, for option 2. Be sure to indicate if the operating profits increase or decrease.

c)         Which option is best? Identify one longer term strategic issue the firm should consider before making the final decision.

Solutions

Expert Solution

a)

Continue Road bike line [1] Drop the road bike line [2] Increase /(decrease) in income if road bike is dropped [2-1]
Sales 1200*4000=4800000 0 -4800000
less:Variable cost 600*4000=-2400000 0 2400000
Fixed cost -2500000 -1000000 [2500000(1-.60 avoidable] 1500000
Increase/(decrease )in income -900000

Operating income will decrease by 900000 if Road bike is dropped.

b)

Continue Road bike line[3] Replace the road bike line with Fat tire [4] Increase /(decrease) in income if road bike is replaced [4-3]
Sales 1200*4000= 4800000 600*10000=6000000 1200000
Variable cost 600*4000=- 2400000 400*10000= -4000000 -1600000
Fixed cost -2500000 -1000000 1500000
Operating income /(loss) -100000 1000000 1100000

Operating income will increase by $ 1,100,000

c)Option 2 is Best as operating income will increase by 1,100,000

The firm should consider the market before introducing fat tire and replacing Road bike line .Whether existing production facilities are enough for production of fat tire or not.

ekkarill92 answered 1 year ago
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