Question

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

	T-1			T-2
Sales	$	300,000		$	340,000
Variable costs:
Cost of goods sold		90,000			170,000
Selling & administrative		15,000			70,000
Contribution margin	$	195,000		$	100,000
Fixed expenses:
Fixed corporate costs		80,000			95,000
Fixed selling and administrative		32,000			41,000
Total fixed expenses	$	112,000		$	136,000
Operating income	$	83,000		$	(36,000	)

Required:

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 from dropping T-2? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).)

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 by $58,500? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).)

Answer 1

Answer :-

1 ) :-

Particulars	T-1	T-2
Sales	$300,000	$340,000
Variable costs of goods sold	$90,000	$170,000
Variable selling and administration	$15,000	$70,000
Contribution margin	$195,000	$100,000
Contribution margin ratio	= $195,000 / $300,000 = 0.6500 = 65.00%	= $100,000 / $340,000 = 0.2941 = 29.41%
Incremental contribution margin from T-1 if T-2 is dropped	= $195,000 * 10% = $19,500
Net effect of discounting T-2		= $19,500 - $100,000 = - $80,500

2 ) :-

Here, we need to findout the sales percentage for T-1 .

Sales percentage for T-1 = Loss of contribution margin T-2 / Gain in contribution margin T-1

= $100,000 /  $195,000

= 0.5128

= 51.28%

Sales percentage for T-1 = 51.28%

3 ) :-

Here, we need to findout the percentage increase in sales from T-1 .

Percentage increase in sales from T-1 = [ Loss of contribution margin T-2 - total fixed cost reduced ] / Gain in contribution margin T-1

= [ $100,000 - $58,500 ] / $195,000

= 41,500 / 195,000

= 0.2128

= 21.28%

Percentage increase in sales from T-1 = 21.28%