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Effects of dropping one model from product mix

5-50 Relevant Costs: dropping a product

Merchant Company manufactures and sells three models of electronic printers. Ken Gail, president of the company, is considering dropping model JT484 from its product line because the company has experienced losses for this product over the past three quarters. The following product-level operating data have been complied for the most recent quarter:

Sales $1,000,000 $500,000 $200,000 $300,000
Variable Costs 600,000 300,000 100,000 200,000
Contribution Margin 400,000 200,000 100,000 100,000
Fixed Costs:
Rent 50,000 25,000 10,000 15,000
Depreciation 60,000 30,000 12,000 18,000
Utilities 40,000 20,000 5,000 15,000
Supervision 50,000 15,000 5,000 30,000
Maintenance 30,000 15,000 6,000 9,000
Administrative 100,000 30,000 20,000 50,000
Total Fixed Costs 330,000 135,000 58,000 137,000
Operating income (loss) 70,000 65,000 42,000 (37,000)

In addition, the following information is also available:

? Factory rent and depreciation will not be affected by a decision to drop model JT484.
? Quarterly utility bills will be reduced from $40,000 to $31,000 if JT484 is dropped.
? Supervision costs for JT484 can be eliminated if dropped.
? The maintenance department will be able to reduce quarterly costs by $7,000 if JT484 is dropped.
? Elimination of JT484 will make it possible to eliminate two administrative staff positions with combined salaries of $30,000 per quarter.

A. Should Merchant Company eliminate JT484?
B. Merchant's sales manager believes that it is important to continue to produce JT484 to maintain a full product line. He expects the elimination of JT484 will reduce sales of the remaining two products by 5% each. Will this information change your answer to (a)? Explain.

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Solution Preview

a. If the company eliminates the product, its new numbers will become:

Sales $700,000
Variable Costs ($400,000)
Contribution Margin $300,000

Rent ($50,000) unaffected by change
Depreciation ($60,000) unaffected by change
Utilities ($31,000) reduced by $9000 by change
Supervision ($20,000) ...

Solution Summary

A financial analysis of whether one model amongst a company's product mix should be dropped including the effects upon total contribution margin and fixed cost coverage.