Question

Based on the following analysis of last year’s operations of Moline Inc., a financial vice president of the company believes that the firm’s total net income could be increased by $500,000 if its design division were discontinued. (Amounts are given in thousands of dollars.) Totals All Other Divisions Design Division Sales $23,500 $18,000 $5,500 Product costs: Variable (9,500) (7,000) (2,500) Fixed (6,000) (5,000) (1,000) Gross profit $8,000 $6,000 $2,000 Operating expenses: Variable (4,200) (2,500) (1,700) Fixed (2,300) (1,500) (800) Net income (loss) $1,500 $2,000 $500 Required: a. Assuming that total fixed costs and expenses would not be affected by discontinuing the design division, compute the increase (decrease) in net income. b. Assume that discontinuance of the design division will enable the company to avoid 70% of the fixed portion of product costs and 80% of the fixed operating expenses allocated to the design division. Calculate the increase (decrease) in net income.

Answer 1

a)

particulars	current activity	proposed activity	difference in amount
sales	23500	18000	(5500)
product costs:
variable costs	(9500)	(7000)	2500
fixed costs	(6000)	(6000)	0
gross profit	8000	5000	(3000)
operating expenses
variable costs	(4200)	(2500)	1700
fixed costa	(2300)	(2300)	0
NET INCOME	1500	200	(1300)

difference in amount = proposed activity - current activity

The total fixed costs and fixed expenses would not be affected,

so the costs and expenses remains same.

THUS, THE NET INCOME WOULD DECREASED BY $ 1300.

b)

particulars	current activity	proposed activity	difference in amount
sales	23500	18000	(5500)
product costs:
variable costs	(9500)	(7000)	2500
fixed costs	(6000)	(5300) w.n 1	700
gross profit	8000	5700	(2300)
operating expenses:
variable expenses	(4200)	(2500)	1700
fived expenses	(2300)	(1660) w.n 2	640
NET INCOME	1500	1540	40

WORKING NOTE 1:

70% of fixed costs are avoided

proposed fixed costs are = 5000+(1000*30%)

= 5000 + 300

= $ 5300

WORKING NOTE 2:

80% of fixed expenses are avoided

proposed fixed expenses are = 1500 + (800*20%)

= 1500 + 160

= $ 1660

THUS, THE NET INCOME WOULD INCREASED BY $40