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Effects of dropping one model from product mix

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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.

Similar Posting

Cost Allocation Table and Cover Memo

You are the Division Manager for personal computers at Technology Unlimited. As the Division Manager, you are responsible for deciding which PC's to manufacture. Currently your division manufactures three different models of personal computers:

1. Your Entry Level PC is losing money. Sales are $200,000 on 20,000 units. Variable costs are $100,000 and fixed costs are $110,000, for an overall loss of $10,000.
2. The Standard PC is making money. Sales are $450,000 on 30,000 units, with variable costs of $270,000 and fixed costs of $165,000 for an overall profit of $15,000.
3. The Deluxe PC is making the big bucks for the division. Sales are $1,000,000 on 50,000 units, with variable costs of 600,000 and fixed costs of 275,000 for an overall profit of $125,000.

The president of the company is Nancy Williams. She suggests dropping the Entry Level model and concentrating on the two other models. You reply that this would lead to a cost allocation death spiral. She says, "Prove it, or drop the Entry Level model".

Analyze the information and prepare a briefing to Nancy. What will be the effect on the Standard and Deluxe models if you drop the Entry Level model? How strongly should argue for or against the Entry Level PC based on your financial analysis as well as opposition to the model by the president of the company?

Deliverable 1 - Cost Allocation

Create a table for the financial information if the three product lines are continued with no changes.

Then, create a second table to show what happens if the Entry Level PC is dropped. If either the Standard of Deluxe models then show a loss as a result of dropping the Entry Level model, then create a third table showing the result of dropping any other unprofitable models.

(see attachment for data)

Deliverable 2 - Cover Memo & Background Info

Create a cover memo for your president that summarizes the financial information in the table. Decide how strongly you want to argue in favor or against the Entry Level PC and make your case.

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