Bern, Inc. is considering dropping one product line due to continuing losses. If

Question

Bern, Inc. is considering dropping one product line due to continuing losses. If the product line is discontinued, then Bern could avoid $111,300 per year in fixed costs. Revenue and cost data for the product line for the past year follow:

Sales (20,000 units)

$300,000

Variable costs

180,000

Contribution margin

120,000

Fixed costs

140,000

a. From a purely economic perspective, Bern would be indifferent between discontinuing or continuing the product line at 18,550 units of annual sales. Why?

b. Suppose that if the product line were dropped, the production and sale of other products would increase so as to generate a $15,000 increase in the contribution margin received from the other products. If all other conditions are the same (and the fixed cost reduction of $111,300 is still applicable), what is the change in annual operating income from dropping the product line?

Sales (20,000 units)

$300,000

Variable costs

180,000

Contribution margin

120,000

Fixed costs

140,000

Explanation / Answer

A. OPERATING INCOME AT 18550 UNIT OF ANNUAL SALES

SALES ($300000/20000 * 18550) = $278250

LESS VARIABLE COST($180000/20000 * 18550) =($166950)

CONTRIBUTION MARGIN ($278250-166950) =$111300

FIXED COST =$111300

AT 18550 UNIT LEVEL THE CONTRIBUTION MARGIN AND THE FIXED COST IS EQUAL I;E NO PROFIT NO LOSS LEVEL, SO BERN CAN BE INDIFFERENT DISCONTINUEING OR CONTINUEING THE PRODUCT LINE.

B.-

ANNUAL OPERATING INCOME BEFORE DROPING THE PRODUCT LINE-

CONTRIBUTION MARGIN =$120000

LESS FIXED COST =($140000)

ANNUAL OPERATING LOSS =($20000)

ANNUAL OPERATING INCOME AFTER DROPING THE PRODUCT LINE-

CONTRIBUTION INCREASE =$15000

LESS- BALANCE FIXED COST($140000 - $111300) =$28700

ANNUAL OPERATING LOSS =($13700)

AFTER DROPPING THE PRODUCT LINE THE ANNUAL OPERAING LOSS CAN BE MINIMISED TO $13700

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