Sunland Toys\' management is considering eliminating product A, which has been s

Question

Sunland Toys' management is considering eliminating product A, which has been showing a loss for several years. The company's annual income statement, is as follows: Total Sales aiab expenses Contribution margin $2,289,000 1,405,000 $1,801,500 5,495,500 601,400 1,099,000 3,392,400 $597,000 $803,600 $702,500 $2,103,100 $527,000 428,000 $522,000 $1,477,000 47,700 106,000 279,500 $635,500 S518,800 $649,900 $1,804,200 $52,600 $298,900 1,692,000 Advertising expense Depreciation expense 15,100 93,400 10,700 80,100 21,900 Corporate expenses Total fixed expenses Operating income $(38,500) $284,800 Advertising expense Specific to each product. Depreciation expense Specific to each product; no other use available, no resale value. Corporate expenses - Allocated based on number of employees.

Explanation / Answer

Sunland Toys

Product A earns a contribution margin of $597,000

Contribution lost of product A were discontinued    -$597,000

Avoidable fixed cost (advertising expense)              $527,000

Excess of contribution lost                                        -$70,000

Hence, if product A were dropped, the net income decreases by $70,000.

Selling price of new product $10 per unit

Variable cost                          $5

Contribution margin per unit $5

Fixed cost – advertising cost specific to that of product A = $527,000

Hence the desired number of units = $527,000/$5 =105,400 units

At this point the new product would make no profit or loss (since this a break-even point in sales). However, the contribution earned would be adequate to absorb the specific fixed cost – avoidable, which makes the product worthwhile to produce. The allocated fixed costs - depreciation expense and corporate expenses are not relevant.

Any product that earns a contribution is worthwhile. Hence, the sales in terms of units at break-even point is to be calculated. Since at break-even point, the contribution earned is adequate to absorb the entire fixed cost without leaving any profit or loss.

The answer to this would vary if the entire fixed costs are considered.

If the fixed cost further includes depreciation expense and corporate expenses, which total to $108,500 and the total fixed cost is $635,500 then the desired units = $635,500/$5 =127,100

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