Keep-or-Drop Decision Direct fixed expenses consist of depreciation and plant su
ID: 2505165 • Letter: K
Question
Keep-or-Drop Decision
Direct fixed expenses consist of depreciation and plant supervisory salaries. All depreciation on the equipment is dedicated to the product lines. None of the equipment can be sold.
Assume that each of the three products has a different supervisor whose position would remain if the associated product were dropped.
Required:
Conceptual Connection: Estimate the impact on profit that would result from dropping Conway. Enter amount in full, rather than in thousands. For example, "15000" rather than "15".
$______
Explanation / Answer
If Petoskey drops Conway, profit will decrease by $75,000 as a result of the lost contribution margin
($300,000 $225,000). Note that the direct fixed expense for depreciation is a sunk cost and not relevant to
the decision (i.e., it will remain unchanged whether Conway is kept or dropped). In addition, Petoskey will
avoid the $80,000 supervisory salary cost if it drops Conway. Finally, if Petoskey drops Conway, 20% of
Alansons contribution margin, or $33,000 (i.e., .20 $165,000), will also be lost as Conway-loving
customers shop elsewhere for Alanson.
Therefore, the overall impact of dropping Conway is that profit decreases by the 75,000 lost Conway
contribution margin, increases by the lost Conway supervisory salary of $80,000, and decreases by the lost
Alanson contribution margin of $33,000, which is a net decrease in profit of $28,000. Therefore, Petoskey
should keep Conway because profits are higher with Conway than without Conway.
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