Problem 2 Blues Company produces and sells 3 styles of office chairs – Standard,
ID: 2599951 • Letter: P
Question
Problem 2
Blues Company produces and sells 3 styles of office chairs – Standard, Deluxe and Premium. Below is an analysis of the Operating Profit report, which is prepared in a Contribution Margin format.
Product Lines
Standard
Deluxe
Premium
Total
Selling price per unit
$134.40
$187.50
$295.38
$171.65
Sales
$336,000
$150,000
$192,000
$678,000
Less: variable costs
72,000
80,000
88,000
240,000
Contribution margin
$264,000
$70,000
$104,000
$438,000
Less: fixed expenses
147,848
47,311
38,441
233,600
Net operating income
$116,152
$22,689
$65,559
$204,400
In examining the report, company management contemplates eliminating Deluxe and increasing investment in one of the other product lines either Standard or Premium. You have been asked to advise management concerning this decision.
Required
Assuming fixed costs are allocated to each Product line based on unit sales:
Compute the Break-even in product sales for each product line
As currently presented
For Standard and Premium, assuming they eliminate the Deluxe product line.
Compute Operating Leverage for Standard and Premium
As currently presented
Assuming they eliminate the Deluxe product line.
Using your analysis from parts 1 & 2, can you suggest several reasons for keeping the Deluxe product line? Please explain.
If the company eliminates Deluxe, which product line should they increase their investment in, Standard or Premium? Please explain your answer.
Product Lines
Standard
Deluxe
Premium
Total
Selling price per unit
$134.40
$187.50
$295.38
$171.65
Sales
$336,000
$150,000
$192,000
$678,000
Less: variable costs
72,000
80,000
88,000
240,000
Contribution margin
$264,000
$70,000
$104,000
$438,000
Less: fixed expenses
147,848
47,311
38,441
233,600
Net operating income
$116,152
$22,689
$65,559
$204,400
Explanation / Answer
Blues Company
Computation of break-even in product sales for each product line as currently presented:
Break-even in product sales = fixed cost/contribution margin ratio
Break-even in unit sales = fixed cost/unit contribution margin
Fixed cost – allocated based on unit sales of each product line
Standard
Deluxe
Premium
Total
Fixed cost
$147,848
$47,311
$38,441
$233,600
Contribution margin
$264,000
$70,000
$104,000
$438,000
Contribution margin ratio
78.57%
46.67%
54.17%
Break-even product sales
$188,174
$101,372.00
$70,964
$360,510
Break-even unit sales
1,400
540
$240
2,180
Contribution margin ratio = (contribution margin/sales) x100
Standard = 264,000/336,000 = 78.57%
Deluxe = 70,000/150,000 = 46.67%
Premium = 104,000/192,000 = 54.17%
Break-even product sales = fixed cost / contribution margin ratio
Standard = 147,848/78.57% = $188,174
Deluxe = 47,311/46.67% = $101,372
Premium = 38,441/54.17% = $70,964
Computation of break-even product sales for Standard and Premium assuming, Deluxe is eliminated:
When Deluxe is eliminated, the fixed cost of Deluxe is allocated to Standard and Premium on the basis of their unit sales.
Standard
Premium
Total
unit sales
2,500
650
3,150
Proportion
79.37%
20.63%
100
allocated fixed cost of Deluxe
$37,551
$9,760
$47,311
actual fixed costs
$147,848
$38,441
$185,289
Total fixed costs
$185,399
$48,201
$233,600
contribution margin ratio
78.57%
54.17%
Break-even product sales
$533,281
$88,981
$622,262
Break-even product in units
3,967
$301
4,268
Operating leverage = contribution/net income
Standard = $264,000/$116,152 = 2.28
Premium = $104,000/$65,559 = 1.59
Assuming the company eliminates the Deluxe product line,
Reasons in support of not eliminating the Deluxe product line.
Assuming the company eliminates Deluxe, the company should increase their investment in Premium product line.
On comparison of unit contribution margin of Standard and Premium, the Premium product line earns higher unit contribution margin and hence the company should invest in Premium as shown below,
Standard
Premium
unit sales
2,500
650
Contribtuion margin
$264,000
$104,000
Unit contribution margin
$105,60
$160
Unit contribution margin = contribution margin/ unit sales
Standard = 264,000/2,500 = $105.60
Premium = 104,000/650 = $160
Standard
Deluxe
Premium
Total
Fixed cost
$147,848
$47,311
$38,441
$233,600
Contribution margin
$264,000
$70,000
$104,000
$438,000
Contribution margin ratio
78.57%
46.67%
54.17%
Break-even product sales
$188,174
$101,372.00
$70,964
$360,510
Break-even unit sales
1,400
540
$240
2,180
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