E7-7 Analyzing Keep-or-Drop Decision [LO 7-2, 7-5] MSI is considering eliminatin

Question

E7-7 Analyzing Keep-or-Drop Decision [LO 7-2, 7-5]

MSI is considering eliminating a product from its ToddleTown Tours collection. This collection is aimed at children one to three years of age and includes “tours” of a hypothetical town. Two products, The Pet Store Parade and The Grocery Getaway, have impressive sales. However, sales for the third CD in the collection, The Post Office Polka, have lagged the others. Several other CDs are planned for this collection, but none is ready for production.

MSI’s information related to the ToddleTown Tours collection follows:

      
*Allocated based on total sales dollars.

MSI has determined that elimination of the Post Office Polka (POP) program would not impact sales of the other two items. The remaining fixed overhead currently allocated to the POP product would be redistributed to the remaining two products.

Required:
1. Calculate the incremental effect on profit if the POP product is eliminated.



2. Should MSI drop the POP product?

3-a. Calculate the incremental effect on profit if the POP product is eliminated. Suppose that $1,200 of the common fixed costs could be avoided if the POP product line were eliminated.



3-b. Should MSI drop the POP product?

Segmented Income Statement for MSI’s ToddleTown Tours Product Lines Pet Store Parade Grocery Getaway Post Office Polka Total Sales revenue $ 150,000 $ 145,000 $ 39,000 $ 334,000 Variable costs 63,000 59,000 35,000 157,000 Contribution margin $ 87,000 $ 86,000 $ 4,000 $ 177,000 Less: Direct Fixed costs 8,800 9,100 3,700 21,600 Segment margin $ 78,200 $ 76,900 $ 300 $ 155,400 Less: Common fixed costs* 7,500 7,250 1,950 16,700 Net operating income (loss) $ 70,700 $ 69,650 $ (1,650 ) $ 138,700

Explanation / Answer

1) Statement Showing Effect on Profit( POP Product Eliminated) Detail Amount Contribution lost on POP Product -$4,000.00 Savings in direct fixed cost $3,700.00 Net Loss -$300.00 Effect on profit Decrease by $300 2) No, Because Eliminating the POP product will further increase the loss by $300 3.a) Statement Showing Effect on Profit( POP Product Eliminated) Detail Amount Contribution lost on POP Product -$4,000.00 Savings in direct fixed cost $3,700.00 Saving in Avoidable Common Cost $1,200.00 Net Loss $900.00 Effect on profit Increase by $900 3.b) Yes, Because Eliminating the POP product will further increase the profit by $900

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