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	37,800
Total fixed costs			30,430	55,990
Profit			$9,560	$-18,190

$15,215 of Product A's fixed costs are avoidable; $33,034 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 $29,600. Accompanying the sales increase will be a fixed cost increase of $4,800. 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

= $9,560 + $ - 18,190

= $ - 8,630

Except avoidable fixed costs, remaining fixed costs of ($55,990 - $33,034 = $22,956) 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 + $29,600

= $93,000 + $29,600

= $122,600

New total fixed costs of product A

= Old + $4,800 + Unavoidable fixed costs of product B

= $30,430 + $4,800 + $22,956

= $58,186

Calculations	Particulars	Product A	Product B	Total A + B
A	Sales	122,600	-	122,600
B	Contribution margin ratio	0.43	-	-
C = A x B	Contribution	52,718	-	52,718
D	Total Fixed costs	58,186	-	58,186
E = C - D	Profit	(5,468)	-	(5,468)

So, the losses will reduce from $8,630 to $5,468 and so the proposal should be accepted