Question

Cool Rays Ltd. is considering dropping its Tinted Glass product line. The Tinted Lens product line income statement for the last year was as follows:

sales		1,850,000
Cost of goods sold
variable manufacturing portion	1,080,000
fixed manufacturing portion	720,000	1,800,000
gross profit		50,000
selling and administration
comissions (10% based on sales)	185,000
advertising for tinted glass line	115,000
allocated head office expenses	45,000	345,000
operating loss		-295,000

The company has a total of 3 product lines. Only $200,000 of fixed manufacturing costs can be eliminated if the Tinted Lens product line is discontinued.   The balance of the fixed manufactured costs have been allocated to the product line on the basis of sales.  

a) Should Cool Rays drop the Tinted Glass product line?

b) By how much would operating income increase or decrease if the product line is dropped? Show your work.

c) Irrespective of your calculation above, very briefly list two other considerations that should influence senior management’s decision in decisions of this type?

Regardless of your answer above, assume the company would lose $200,000 if the Tinted Lens product line were dropped. Also assume that if the Tinted Glass product line was dropped the company could introduce a new product line Z, which is quite unique in the market place. The following information relates to this possibility:

Sales of product line Z                                    $1,000,000

Variable manufacturing costs                          50% of selling price

Sales commissions                                         10% of selling price

Required advertising for product line Z           $75,000

The amount allocated to product line Z for fixed manufacturing expenses and head office expenses would remain the same.

d) Should the company drop the Tinted Lens product line and introduce the new product line Z? (There is insufficient capacity to sell both product lines.)

e)By how much will operating income increase or decrease if the company discontinues the Tinted glass product line and introduces Z? Show your work.

Answer 1

	1
			Sales		18,50,000
			Cost of Goods Sold:
			Variable Manufacturing Cost	10,80,000
			Variable Selling & Admin Cost	1,85,000
			Gross Profit		5,85,000
			Less: Avoidable Fixed M.Cost	2,00,000
			Less: Avoidable Advertising Cost	1,15,000
			Net Income from Division		2,70,000
		Note:	Fixed Manuafcturing Cost (720000-200000) will still be allocable if tinted division continues or not
			Allocated Head office expense will still be allocable if tinted division continues or not
			Both above cost are irrelevant/sunk costs for decision
			Since the Tinted Division is providing Positive 270000 Net Income it should be continues
	2				Division closed
			Sales		0
			Cost of Goods Sold:
			Variable Manufacturing Cost	0
			Variable Selling & Admin Cost	0
			Gross Profit		0
			Fixed Manufacturing Cost	5,20,000
			Allocated Head Office Expense	45,000
			Net Loss post closure		-5,65,000
			Current Loss in Tined Depatement		-2,95,000
			Loss will increase by		-2,70,000
	3	a	The kind of product tinted department is offering, whether it will impact market reputation of company for other products
		b	Other factor like suppliers agreements, capital commitments may be a concern
	4				Division Z
			Sales		10,00,000
			Cost of Goods Sold:
			Variable Manufacturing Cost	5,00,000
			Variable Selling & Admin Cost	1,00,000
			Gross Profit		4,00,000
			Fixed Manufacturing Cost	5,20,000
			Advertisng Expense	75,000
			Allocated Head Office Expense	45,000
			Net Loss post closure		-1,65,000
			Loss in Tinted Division	-2,95,000
			Loss in Z Division	-1,65,000
			Since the loss has declined the company should go for product Z
	5		Change in Operating Margin	1,30,000
			Operating Margin will Increase