A candy company makes Chocolate and Peanut clusters which produced the following
ID: 2376297 • Letter: A
Question
A candy company makes Chocolate and Peanut clusters which produced the following results last year.
Chocolate
Peanut
Total
Sales
$500,000
$600,000
$1,100,000
Variable costs
420,000
350,000
$770,000
Contribution margin
80,000
250,000
$330,000
Direct fixed costs
50,000
15,000
$65,000
Allocated fixed costs
45,000
55,000
$100,000
Net Income
($15,000)
$180,000
$165,000
A. Should the Chocolate be dropped?
B. Explain your answer for item (a).
C. What would happen to overall net income if the chocolate was dropped?
D. Assume the chocolate clusters are not dropped and the peanut lost 15% of its sales. What would be the effect on net income?
A candy company makes Chocolate and Peanut clusters which produced the following results last year.
Chocolate
Peanut
Total
Sales
$500,000
$600,000
$1,100,000
Variable costs
420,000
350,000
$770,000
Contribution margin
80,000
250,000
$330,000
Direct fixed costs
50,000
15,000
$65,000
Allocated fixed costs
45,000
55,000
$100,000
Net Income
($15,000)
$180,000
$165,000
Explanation / Answer
A. Operating income for Chocolate before allocated fixed cost = contribution margin - direct fixed cost = 80,000-50,000 = 30,000
As this is positive, Chocolate should NOT be dropped. (Note that we should not consider the allocated fixed cost of 45,000 as this is an allocated cost and would be incurred anyway even if Chocolate is dropped).
B. The explanation is as above. The allocated cost should not be considered in our evaluation as it would be incurred anyway.
C. If chocolate is dropped, then net income would fall by the amount of operating income before allocated fixed cost which is equal to 30,000 (as calculated above). So net income would be 165,000-30,000 = $135,000
D. If chocolate is not dropped and peanut lost 15% of sales, then new peanut sales = 600,000*85% = 510,000
Variable costs for peanuts = old variable cost * (new sales / old sales) = 350,000 * (510,000/600,000) = 297,500
So new contribution margin for peanuts = 510,000-297,500 = 212,500
So reduction in contribution margin = 250,000 - 212,500 = 37,500
This would be the reduction in net income.
So new net income = 165,000 - 37500 = $127,500
Hope this helped ! Let me know in case of any queries.
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