Dropping Unprofitable Division Based on the following analysis of last year’s op
ID: 2534846 • Letter: D
Question
Dropping Unprofitable Division Based on the following analysis of last year’s operations of
Groves, Inc., a financial vice president of the company believes that the firm’s total net income could
be increased by $160,000 if its design division were discontinued. (Amounts are given in thousands
of dollars.)
Totals /All Other Divisions/ Design Division
Sales. . . . . . . . . . . . . . . . . . . . . . $18,800 $14,400 $4,400
Cost of services:
Variable . . . . . . . . . . . . . . . . . . (7,600) (5,600) (2,000)
Fixed . . . . . . . . . . . . . . . . . . . . (4,800) (4,000) (800)
Gross profit . . . . . . . . . . . . . $ 6,400 $ 4,800 $1,600
Operating expenses:
Variable . . . . . . . . . . . . . . . . . . (3,360) (2,000) (1,360)
Fixed . . . . . . . . . . . . . . . . . . . . (1,600) (1,200) (400)
Net income (loss) . . . . . . . . . . . . $ 1,440 $ 1,600 $ (160)
Required
Provide answers for each of the following independent situations:
a. Assuming that total fixed costs and expenses would not be affected by discontinuing the design
division, prepare an analysis showing why you agree or disagree with the vice president.
b. Assume that discontinuance of the design division will enable the company to avoid 30% of the
fixed portion of cost of services and 40% of the fixed operating expenses allocated to the design
division. Calculate the resulting effect on net income.
c. Assume that in addition to the cost avoidance in requirement (b), the capacity released by discon-
tinuance of the design division can be used to provide 6,000 new services that would have a vari-
able cost per service of $60 and would require additional fixed costs totaling $68,000. At what
unit price must the new service be sold if Groves is to increase its total net income by $180,000?
Explanation / Answer
a. Assuming that total fixed costs and expenses would not be affected by discontinuing the design division, prepare an analysis showing why you agree or disagree with the vice president.
Ans
If design department is discontinued the following assumptions are taken
The total net income is calculated if design department is discontinued
amount in thousands
Total
other divisions
design division is discontinued
sales
14400
14400
cost of services
0
variable
-5600
-5600
fixed
-4800
-4000
-800
total
-10400
-9600
-800
Gross profit
4000
4800
-800
operating expenses
0
variable
-2000
-2000
fixed
-1600
-1200
-400
total
-3600
-3200
-400
Net income(loss)
400
1600
-1200
The net profit has decreased to $400,000 from earlier $1440,000 if design department is discontinued. Disagree with vice president analysis
b. Assume that discontinuance of the design division will enable the company to avoid 30% of the fixed portion of cost of services and 40% of the fixed operating expenses allocated to the design division. Calculate the resulting effect on net income.
Ans
The following assumptions are taken if design department is discontinued . the expenses of design department will have the following
The total net income is calculated if design department is discontinued
amount in thousands
Total
other divisions
design division is discontinued
sales
14400
14400
cost of services
0
variable
-5600
-5600
fixed
-4560
-4000
-560
total
-10160
-9600
-560
Gross profit
4240
4800
-560
operating expenses
0
variable
-2000
-2000
fixed
-1440
-1200
-240
total
-3440
-3200
-240
Net income(loss)
800
1600
-800
The total net profit will be $800,000
c. Assume that in addition to the cost avoidance in requirement (b), the capacity released by discontinuance of the design division can be used to provide 6,000 new services that would have a variable cost per service of $60 and would require additional fixed costs totaling $68,000. At what unit price must the new service be sold if Groves is to increase its total net income by $180,000?
Ans
Requirement
Cost of service = $560,000
Operative expenses = $240,000
Additional fixed cost =$68,000
The total fixed cost = $560,000+$240,000+$68,000 =$868,000
The variable cost will be = 6000 x $60 = $360,000
The total revenue to be generated = total fixed cost + total variable cost + target profit
= $868,000 + $360,000+$180,000
=$1,408,000
Per unit sales price = Total revenue / additional units of sales
= $1408000 / 6000
= 234.6667
The unit price should be $234.67
amount in thousands
Total
other divisions
design division is discontinued
sales
14400
14400
cost of services
0
variable
-5600
-5600
fixed
-4800
-4000
-800
total
-10400
-9600
-800
Gross profit
4000
4800
-800
operating expenses
0
variable
-2000
-2000
fixed
-1600
-1200
-400
total
-3600
-3200
-400
Net income(loss)
400
1600
-1200
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