Laundry Fresh provides commercial laundry and dry cleaning services to local hos
ID: 2492513 • Letter: L
Question
Laundry Fresh provides commercial laundry and dry cleaning services to local hospitals, hotels, and restaurants. Management believes that the dry cleaning business is a "loser," even though dry cleaning operations yield a high contribution margin. Moreover, based on summary financial data from the most recent year of operations (presented below) management is seriously considering getting out of the dry cleaning business. Laundry Dry Cleaning Total Revenue 3,000,000 1,000,000 4,000,000 Less: Variable costs 1,000,000 200,000 1,200,000 Contribution margin 2,000,000 800,000 2,800,000 Less: Traceable fixed costs 1,000,000 500,000 1,500,000 Less: Common fixed costs 500,000 500,000 1,000,000 Profit 500,000 (200,000) 300,000 Traceable fixed costs are incurred directly by the identified line of business. Common fixed costs are common to both lines of business and have been arbitrarily allocated equally to each line, e.g., sales force, reception, and delivery trucks. REQUIRED: a. Assume that common fixed costs would decrease by $200,000 if the dry cleaning business were closed. By how much will Laundry Fresh's profit increase or decrease if it closes the dry cleaning operations? b. Suppose that closing the dry cleaning business would increase overall laundry revenue by 10%. Specifically, while some customers would be lost because they value one-stop cleaning convenience, the sales force will be better able to focus its efforts because there will be only one product line. How does this information affect your answer to part (a)? That is, by how much will Laundry Fresh's profit increase or decrease if it closes the dry cleaning operations? Laundry Fresh provides commercial laundry and dry cleaning services to local hospitals, hotels, and restaurants. Management believes that the dry cleaning business is a "loser," even though dry cleaning operations yield a high contribution margin. Moreover, based on summary financial data from the most recent year of operations (presented below) management is seriously considering getting out of the dry cleaning business. Laundry Dry Cleaning Total Revenue 3,000,000 1,000,000 4,000,000 Less: Variable costs 1,000,000 200,000 1,200,000 Contribution margin 2,000,000 800,000 2,800,000 Less: Traceable fixed costs 1,000,000 500,000 1,500,000 Less: Common fixed costs 500,000 500,000 1,000,000 Profit 500,000 (200,000) 300,000 Traceable fixed costs are incurred directly by the identified line of business. Common fixed costs are common to both lines of business and have been arbitrarily allocated equally to each line, e.g., sales force, reception, and delivery trucks. REQUIRED: a. Assume that common fixed costs would decrease by $200,000 if the dry cleaning business were closed. By how much will Laundry Fresh's profit increase or decrease if it closes the dry cleaning operations? b. Suppose that closing the dry cleaning business would increase overall laundry revenue by 10%. Specifically, while some customers would be lost because they value one-stop cleaning convenience, the sales force will be better able to focus its efforts because there will be only one product line. How does this information affect your answer to part (a)? That is, by how much will Laundry Fresh's profit increase or decrease if it closes the dry cleaning operations?Explanation / Answer
Answer
Answer (a)
Figures in $
Particulars
Amount
Contribution margin Lost (Dry cleaning)
a
-8,00,000
Saving in traceable fixed costs (Dry cleaning)
b
5,00,000
Saving in common fixed costs
c
2,00,000
Total Decrease in profit of Laundry fresh on closing of dry cleaning business (a+b+c)
-1,00,000
Answer (b)
Figures in $
Particulars
Amount
Contribution margin Lost (Dry cleaning)
a
-8,00,000
Saving in traceable fixed costs (Dry cleaning)
b
5,00,000
Saving in common fixed costs
c
2,00,000
Decrease in profit on closing of dry cleaning business (a+b+c)
d
-1,00,000
Increase in revenue of laundry business
e
300000
(3,000,000*0.10)
Increase in variable cost of laundry business
f
100000
(1000000*0.1)
Increase in contribution margin of laundry business (e-f)
g
200000
Total net increase in profits of Laundry Fresh (d+g)
1,00,000
Figures in $
Particulars
Amount
Contribution margin Lost (Dry cleaning)
a
-8,00,000
Saving in traceable fixed costs (Dry cleaning)
b
5,00,000
Saving in common fixed costs
c
2,00,000
Total Decrease in profit of Laundry fresh on closing of dry cleaning business (a+b+c)
-1,00,000
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