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	$	235,000		$	288,000
Variable costs:
Cost of goods sold		77,000			144,000
Selling & administrative		17,000			57,000
Contribution margin	$	141,000		$	87,000
Fixed expenses:
Fixed corporate costs		67,000			82,000
Fixed selling and administrative		19,000			28,000
Total fixed expenses	$	86,000		$	110,000
Operating income	$	55,000		$	(23,000）

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 $50,000? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).)

Answer 1

1	The expected change in annual operating income by dropping T-2 and selling only T-1.
		Old		New
		T-1	T-2	T-1	T-2
	Sales	$        235,000	$            288,000	$        258,500	$                     -
	Variable costs:
	Cost of goods sold	$          77,000	$            144,000	$          84,700	$                     -
	Selling & administrative	$          17,000	$               57,000	$          18,700	$                     -
	Contribution margin	$        141,000	$               87,000	$        155,100	$                     -
	Fixed expenses:
	Fixed corporate costs	$          67,000	$               82,000	$          67,000	$            82,000
	Fixed selling and administrative	$          19,000	$               28,000	$          19,000	$            28,000
	Total fixed expenses	$          86,000	$            110,000	$          86,000	$          110,000
	Operating income	$          55,000	$            (23,000)	$          69,100	$       (110,000)
	Total income/(loss)		$       32,000		$          (40,900)
	By dropping T-2 & selling T-1, loss amounting to $.40,900 is expected.
	Note: Sale of T-1 has been increased by 10%, accordingly variable cost has also been increased by 10%
2	Dropping T-2 results into Net loss of $40000 and profit forgone of $32000 i.e. total financial loss of $72900. To recover that sale price has been increased by 61.7%.
		Old		New
		T-1	T-2	T-1	T-2	% CHANGE
	Sales	$        235,000	$            288,000	$        379,998	$                     -	61.7%
	Variable costs:
	Cost of goods sold	$          77,000	$            144,000	$        124,509	$                     -	61.7%
	Selling & administrative	$          17,000	$               57,000	$          27,489	$                     -	61.7%
	Contribution margin	$        141,000	$               87,000	$        228,000	$                     -	61.7%
	Fixed expenses:
	Fixed corporate costs	$          67,000	$               82,000	$          67,000	$            82,000
	Fixed selling and administrative	$          19,000	$               28,000	$          19,000	$            28,000
	Total fixed expenses	$          86,000	$            110,000	$          86,000	$          110,000
	Operating income	$          55,000	$            (23,000)	$        142,000	$       (110,000)
	Total income/(loss)		$       32,000		$     32,000
	Note: Sale of T-1 has been increased by 61.7%, accordingly variable cost has also been increased by 61.7%
3	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 $50,000 is 26.24%
		Old		New
		T-1	T-2	T-1	T-2	% CHANGE
	Sales	$        235,000	$            288,000	$        296,666	$                     -	26.24%
	Variable costs:
	Cost of goods sold	$          77,000	$            144,000	$          97,206	$                     -	26.24%
	Selling & administrative	$          17,000	$               57,000	$          21,461	$                     -	26.24%
	Contribution margin	$        141,000	$               87,000	$        178,000	$                     -	26.24%
	Fixed expenses:
	Fixed corporate costs	$          67,000	$               82,000
	Fixed selling and administrative	$          19,000	$               28,000
	Total fixed expenses	$          86,000	$            110,000	$        146,000
	Operating income	$          55,000	$            (23,000)	$          32,000
	Total income/(loss)		$       32,000		$     32,000
	Note: Sale of T-1 has been increased by 26.24%, accordingly variable cost has also been increased by 26.24%

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