Question

Vernon Manufacturing Co. produces and sells specialized equipment used in the petroleum industry. The company is organized into three separate operating branches: Division A, which manufactures and sells heavy equipment; Division B, which manufactures and sells hand tools; and Division C, which makes and sells electric motors. Each division is housed in a separate manufacturing facility. Company headquarters is located in a separate building. In recent years, Division B has been operating at a net loss and is expected to continue to do so. Income statements for the three divisions for 2017 follow.

	Division A				Division B				Division C
Sales	$	4,300,000			$	1,250,000			$	4,400,000
Less: Cost of goods sold
Unit-level manufacturing costs		(2,700,000	)			(900,000	)			(2,980,000	)
Rent on manufacturing facility		(510,000	)			(290,000	)			(300,000	)
Gross margin		1,090,000				60,000				1,120,000
Less: Operating expenses
Unit-level selling and admin. expenses		(196,000	)			(64,125	)			(246,000	)
Division-level fixed selling and admin. expenses		(350,000	)			(82,000	)			(327,000	)
Headquarters facility-level costs		(170,000	)			(170,000	)			(170,000	)
Net income (loss)	$	374,000			$	(256,125	)		$	377,000

Required

a-1. Based on the preceding information, recommend whether to eliminate Division B.

a-2. Prepare companywide income statements before and after eliminating Division B.

b. During 2017, Division B produced and sold 25,000 units of hand tools. Calculate the contribution to profit if sales and production increase to 36,000 units in 2018?

c. Suppose that Solomon could sublease Division B's manufacturing facility for $415,000.  Assuming that Division B currently has a production and sales volume of 36,000 units, determine whether Solomon should accept the opportunity to sublease the facility or continue production at Division B.

Answer 1

a-1. It is recommended to eliminate Division B.

This is because the division is generating a loss of $86,125 which will affect the overall profit of the company.

a-2.

Statement of profitability with Diivision B
	Dvision A	Dvision B	Dvision C	Total
Sales	4300000	1250000	4400000	9950000
Cost of goods sold	2700000	900000	2980000	6580000
Contribution margin	1600000	350000	1420000	3370000
Unit level costs:
Rent on manufacturing facility	510000	290000	300000	1100000
Selling and administration expenses	196000	64125	246000	506125
Total unit level costs	706000	354125	546000	1606125
Unit level profit	894000	-4125	874000	1763875
Divisional level selling and administration costs	350000	82000	327000	759000
Dividional profit	544000	-86125	547000	1004875
Headquarters facility level costs				510000
Net income (loss)				494875

Statement of profitability without Diivision B
	Dvision A	Dvision C	Total
Sales	4300000	4400000	8700000
Cost of goods sold	2700000	2980000	5680000
Contribution margin	1600000	1420000	3020000
Unit level costs:
Rent on manufacturing facility	510000	300000	810000
Selling and administration expenses	196000	246000	442000
Total unit level costs	706000	546000	1252000
Unit level profit	894000	874000	1768000
Divisional level selling and administration costs	350000	327000	677000
Dividional profit	544000	547000	1091000
Headquarters facility level costs			510000
Net income (loss)			581000

b. $154,000

Working:

Contribution margin for 25,000 units = $350,000

Contribution margin per unit =$14.00

Contribution margin for 36,000 units =$504,000

Additional contribution to profit with 36,000 units = $154,000 ($504,000 - $350,000)

c.

As the sublease is giving a differential net income of $337,125 it is advised to sublease .

Working:

	Continue	Sub lease	Difference
Contribution margin	504000	405000	-99000
Unit level fixed costs
Rent on manufacturing facility	290000	0	-290000
Selling and administrative expenses	64125	0	-64125
Total unit level costs	354125	0	-354125
Unit level profit	149875	405000	255125
Divisional level selling and administration costs	82000	0	-82000
Divisional profit	67875	405000	337125