One of Eastvaco’s business segments involves the manufacturing of three types of

Question

One of Eastvaco’s business segments involves the manufacturing of three types of book binders. The profit margin on the binders have not met the expectations of the Company’s CEO. He approaches the Plant Manager of the binder plant and asks for suggestions to improve the margin earned on binder sales. The Plant Manager explains to the CEO that increasing the sales price or sales quantity is not possible in such a highly competitive market. Therefore, a reduction in cost may be the only possibility.

The plant manager has the plant controller prepare a segment income statement for each of the three binders. The difference among the binders relates to quality.

Binder A Binder B Binder C Total
Sales Revenue (given in thousands) $500 $800 $150 $1,450
Less Variable expenses 250 480 140 870
Contribution Margin $250 $320 $10 580
Less direct fixed expenses
Advertising 10 10 10 30
Salaries 37 40 35 112
Depreciation 53 40 10 103
Total $100 $90 $55 $245
Segment margin $150 $230 $(45) $335
Less common fixed expenses $125
Operating Income $210

The controller explains that if Binder C was discontinued then the supervisor (represents salaries) could be dismissed. Also, there would be no need for advertising Binder C.

1. Should Binder C be discontinued and if so what other consideration(s) should the company consider before dropping Binder C? Provide calculations to support your answer.

Explanation / Answer

The profit earned by company altogether is 210. If the company decides to drop binder C then the profit will increase even though the company has to bear the depreciation. The profit will be after dropping C : 210 + 35 ( Salaries) + 10 ( Advertising) = 255 Before the company drops Binder C they should take into consideration the effect of decrease in their market shares, if there any way to obtain binder C at a lower cost then they are producing as variable expenses of Binder C are quite high compared to their selling price and how can the company use the idle remaining resources that were used to produce Binder C in alternative ways. Other than that Binder C should be discontinued as that results in a segment margin loss and is not able to over its direct expenses. The discontinuation of Binder C will also increase the profits overall of the company.

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