Questions 7 and 8 refer to the following information: The following information

Question

Questions 7 and 8 refer to the following information: The following information is for X Company's two products, A and B, last year: Sales Total variable costs Total fixed costs Profit Product A $85,820 43,768 52,130 Product B $85,070 51,042 26,170 $7,858 $-10,078 Because of the reported loss for Product A, X Company is considering dropping it. Further analysis reveals that $26,710 of Product A's fixed costs and $5,680 of Product B's fixed costs are common costs that the company allocates to the two products 7. If X Company drops Product A, company profits will change by $-16,632 You are correct. Your receipt no. is 152-137 Previous Tries 8. Assume that sales of Product B can be increased by $15,120 if Product A is dropped. What will be the effect of this increase orn company profits? -9370 Submit Answer Incorrect. Tries 2/5 Previous Tries

Explanation / Answer

7)

Total allocated fixed costs

= Allocated fixed costs of product A + Allocated fixed costs of product B

= $26,710 + $5,680

= $ 32,390

So, If product A is dropped, entire fixed cost will be allocated to product B

Current net profit

= Profit from Product A + Profit from product B

= - $10,078 + $7,858

= - $ 2,220

If product A is dropped, Variable costs and avoidable fixed costs of product A (Total fixed costs – allocated fixed costs) can be avoided but allocated fixed costs of product A will now be borne by product B

So, Net Profit

= Net Profit from product B – Allocated fixed cost of product A

= $7,858 - $26,710

= -$18,852

So, change in profits will be from - $2,220 to - $18,852

So, change

= Closing profit – opening profit

= - $18,852 - $2,220

= -$16,632

8)

Contribution of product B

= Sales – Variable costs

= $85,070 - $51,042

= $34,028

Contribution margin ratio

= Contribution / Sales

= $34,028 / $85,070

= 0.40 or 40%

New sales = Old + Increase in sales

= $85,070 + $15,120

= $100,190

New Contribution

= Sales x Contribution margin ratio

= $100,190 x 40%

= $40,076

New fixed costs of product B

= Old + Allocated fixed costs of product A

= $26,170 + $26,710

= $52,880

So, Net Profit

= Contribution – Fixed costs

= $40,076 - $52,880

= -$12,804

So, change in profits of company

= -$12,804 – ( - $2,220)

= -$12,804 + $2,220

= -$10,584

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