Question

Barbour Corporation, located in Buffalo, New York, is a retailer of hightech products and is known for its excellent quality and innovation. Recently the firm conducted a relevant cost analysis of one of its product 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 statement, he agreed that T-2 should be dropped. If this is done, sales of T-1 are expected to increase by 10% next year; the firm’s cost structure will remain the same.

	T1	T2
SALES	$295,000	$336,000
VARIABLE COGS	89,000	168,000
CONTRIBUTION MARGIN	206,000	168,000
EXPENSES:
FIXED CORPORATE COSTS	79,000	94,000
VARIABLE SELLING / ADMIN	29,000	69,000
FIXED SELLING / ADMIN	31,000	40,000
TOTAL EXPENSES:	139,000	203,000
OPERATING INCOME/LOSS	67,000	(35,000)

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 form dropping T-2? Round to 2 decimal places. 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 to $57,000? Round to 2 decimal places.

Answer 1

Solution 1:

Computation of Contribution margin ratio and fixed costs
Particulars	T1	T2
Sales	$295,000.00	$336,000.00
Variable cost:
Varaible COGS	$89,000.00	$168,000.00
Variable selling & Admin	$29,000.00	$69,000.00
Total Variable Costs	$118,000.00	$237,000.00
Contribution margin	$177,000.00	$99,000.00
Contribution margin ratio	60.00%	29.46%
Fixed Costs:
Fixed corporate costs	$79,000.00	$94,000.00
Fixed Selling / Admin	$31,000.00	$40,000.00
Total Fixed costs	$110,000.00	$134,000.00

Computation of annual operating income after dropping T2
Particulars	Amount
Sales ($295,000*110%)	$324,500.00
Variable cost (40%)	$129,800.00
Contribution margin	$194,700.00
Fixed costs	$244,000.00
Net operating income	-$49,300.00
Operating income before dropping T2	$32,000.00
Expected change in operating income after dropping T2	-$81,300.00

Solution 2:

required operating income after dropping T2 = $32,000

Required contribution margin = $32,000 + $244,000 = $276,000

Required sales = $276,000 / 60% = $460,000

Existing sale of T1 = $295,000

Required percentage increase in sales = ($460,000 - $295,000) / $295,000 = 55.93%

Solution 3:

If total fixed costs reduced by $57,000, then

Required contribution margin = $32,000 + ($244,000 - $57,000) = $219,000

Required sales = $219,000/ 60% = $365,000

Existing sales of T1 = $295,000

Required percentage increase in sales = ($365,000 - $295,000) /$295,000 =23.73%