The following information is for X Company\'s two products, A and B, last year:
ID: 2573919 • Letter: T
Question
The following information is for X Company's two products, A and B, last year:
Because of the reported loss for Product A, X Company is considering dropping it. Further analysis reveals that $28,130 of Product A's fixed costs and $7,550 of Product B's fixed costs are common costs that the company allocates to the two products.
If X Company drops Product A, company profits will change by
Assume that sales of Product B can be increased by $18,150 if Product A is dropped. What will be the effect of this increase on company profits?
Product A Product B Sales $89,690 $91,260 Total variable costs 49,330 53,843 Total fixed costs 76,640 28,090 Profit $-36,280 $9,327Explanation / Answer
X Company
Determination of the effect of dropping Product A on the profits of X Company:
Product A –
Contribution margin = sales – variable cost
CM = $89,690 - $49,330 = $40,360
Avoidable fixed cost = total fixed cost – allocated fixed cost
Total fixed cost = $76,640
Allocated fixed cost = $28,130
Avoidable fixed cost = $48,510
Profit/(Loss) = CM – avoidable fixed cost
= $40,360 - $48,510 = -$8,150
Hence, dropping of Product A would decrease the overall loss by $8,150
Alternatively,
When Product A is dropped, allocated fixed cost of $28,130 will be borne by Product B.
Hence, the overall profit of the Company X would be = Profit of product B – allocated cost of Product A
Profit/(Loss) from Dropping of Product A = $9,327 - $28130 = -$18,803
Current overall profit of Company X = $9,327 - $36,280 = -$26,953
Hence, loss will decrease = $26953 - $18,803 = $8,150
Hence, dropping of Product A would result in an overall loss = $8,150
Analysis of increase in sales of Product B:
Product B –
Sales $91,260
Less: Variable cost $53,843
Contribution margin $35,693
CM Ratio = 35,693/91,260 = 39.11%
CM on increased sales = increased sales x CM ratio
Increased sales = $18,150
CM on increased sales = 18,150 x 39.11% = $7,099
Since no additional fixed costs (other than the allocated costs of Product A) are incurred, the increased sales of $18,150 of Product B would result in an increase in profits by $7,099.
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