Cool Rays Ltd. is considering dropping its Tinted Glass product line. The Tinted
ID: 2540236 • Letter: C
Question
Cool Rays Ltd. is considering dropping its Tinted Glass product line. The Tinted Lens product line income statement for the last year was as follows:
The company has a total of 3 product lines. Only $200,000 of fixed manufacturing costs can be eliminated if the Tinted Lens product line is discontinued. The balance of the fixed manufactured costs have been allocated to the product line on the basis of sales.
Should Cool Rays drop the Tinted Glass product line? By how much would operating income increase or decrease if the product line is dropped? Show your work.
Irrespective of your calculation above, very briefly list two other considerations that should influence senior management’s decision in decisions of this type?
Regardless of your answer above, assume the company would lose $200,000 if the Tinted Lens product line were dropped. Also assume that if the Tinted Glass product line was dropped the company could introduce a new product line Z, which is quite unique in the market place. The following information relates to this possibility:
Sales of product line Z $1,000,000
Variable manufacturing costs 50% of selling price
Sales commissions 10% of selling price
Required advertising for product line Z $75,000
The amount allocated to product line Z for fixed manufacturing expenses and head office expenses would remain the same.
Required: Should the company drop the Tinted Lens product line and introduce the new product line Z? (There is insufficient capacity to sell both product lines.) By how much will operating income increase or decrease if the company discontinues the Tinted glass product line and introduces Z? Show your work.
Explanation / Answer
Sales 1850000 Less : Variable costs Manufacturing portion 1080000 Commissions @10% on sales 185000 Total variable costs 1265000 Contribution margin 585000 Specific fixed cost which can be avoided if Tinted Glass Product Line is discontinued 200000 Requirement Operating Income which will be decreased if we decide to drop the Tinted Glass Product Line 385000 Requirement The two other consideration that should influence the decision of senior management. 1. Once the product line is dropped, the competitors will usurp the market share of the company which will be difficult to get back, if company wants to starts selling this product line again. 2. If the product line is dropped, labor has to be retrenched. If it happens, the company might find it difficult to get them again. Sales of Product Z 1000000 Variable costs of Product Z Manufacturing costs 500000 Sales commissions 100000 Total variable costs 600000 Contribution Margin 400000 Specific fixed costs 75000 Net Operating Income 325000 Less : Opportunity cost of losing income if Tinted Glass Product Line is discontinued 200000 Requirement Thus operating Income will increase by 125000