Question

The following information is for X Company's two products, A and B: Product A Product B Revenue $93,000 $90,000 Total contribution margin 39,990 41,400 Total fixed costs 25,750 57,620 Profit $14,240 $-16,220 $13,648 of Product A's fixed costs are avoidable; $29,962 of Product B's fixed costs are avoidable. X Company plans to drop Product B since it shows a loss and increase sales of Product A by $34,800. Accompanying the sales increase will be a fixed cost increase of $5,000. If X Company drops Product B and increases Product A sales, what will be the effect on firm profits?

Answer 1

Current Profit

= Product A + Product B

= $14,240 + $ - 16,220

= $ - 1,980

Except avoidable fixed costs, remaining fixed costs of ($57,620 - $29,962 = $ 27,658) cannot be avoided and have to be incurred in case of product B

Contribution margin ratio of product A

= Contribution / Sales

= $39,990 / $93,000

= 0.43 or 43%

The following table shows the calculations

New sales of product A

= Old + $34,800

= $93,000 + $34,800

= $ 127,800

New total fixed costs of product A

= Old + $5,000 + Unavoidable fixed costs of product B

= $ 25,750 + $5,000 + $27,658

= $58,408

Calculations	Particulars	Product A	Product B	Total A + B
A	Sales	127,800	-	127,800
B	Contribution margin ratio	0.43	-	-
C = A x B	Contribution	54,954	-	54,954
D	Total Fixed costs	58,408	-	58,408
E = C - D	Profit	(3,454)	-	(3,454)

So, the losses will increase from $1,980 to $3,454 and so the proposal should not be accepted