Question

New Brands Company is currently operating at 80 percent capacity. Worried about the company's performance, the general manager reviewed the company's operating performance. (All fixed costs are allocated costs.)

Segment	North	South	East	West
Sales	30	40	20	10
Less: variable costs	11	8	21	8
Contribution margin	19	32	(1)	2
Less: fixed costs	9	12	6	3
Operating profit (loss)	10	20	(7)	(1)

REQUIRED:

a.	What is the current operating profit for the company as a whole?
b.	If the manager eliminated the two unprofitable segments, what would be the new operating profit for the company as a whole?
c.	How can management maximize profits?

Answer 1

Solution A

Operating profit for the company as a whole or Total Profit

= Profit of North + Profit of South - Loss of East - Loss of West

=$10 + $20 + ($7) + ($1)

= $ 22 (Answer)

Solution B

Segments remaining after elimination of two unprofitable (East and West) segments will be North and South.

Remaining contribution margin

= Contribution margin of North + Contribution margin of south

= $ 19 + $ 32

=$ 51

Total fixed costs

= Fixed cost of North + Fixed cost of South + Fixed cost of East+ Fixed cost of West

= $ 9 + $ 12 +$ 6 + $ 3

= $ 30

New operating profit

= Remaining contribution margin- Total fixed costs

=$ 51 - $ 30

=$21 (Answer)

Note: Fixed cost is unavoidable and the company will not be able to cut even if the segment is discontinued. They will be allocated to the remaining segments. And that is why remaining contribution is calculated in the beginning of solution of this sub-part.

Solution C

The company should sell only the East segment, because this segment has a negative contribution margin. The remaining three segments that are North South and West will contribute a total of $53 ($ 19 + $ 32 + $ 2). Therefore, after subtracting fixed costs of $30, the resulting profit will be $23.

Calculation: (After Elimination of East Region)

Remaining contribution margin

= Contribution margin of North + Contribution margin of south +   Contribution margin of West

= $ 19 + $ 32 + $ 2

=$ 53

Total fixed costs

= Fixed cost of North + Fixed cost of South + Fixed cost of East+ Fixed cost of West

= $ 9 + $ 12 +$ 6 + $ 3

= $ 30

New operating profit

= Remaining contribution margin- Total fixed costs

=$ 53 - $ 30

=$23

So, in this way the company can maximize its profits by eliminating East segment (the one having negative contribution margin).