Structuring a Keep-or-Drop Product Line Problem with Complementary Effects Shown
ID: 2547134 • Letter: S
Question
Structuring a Keep-or-Drop Product Line Problem with Complementary Effects Shown below is a segmented income statement for Hickory Company's three wooden flooring product lines: Strip Plank Parquet Total Sales revenue $400,000 $200,000 $300,000 $900,000 Less: Variable expenses 225,000 120,000 250,000 595,000 Contribution margin $175,000 $ 80,000 $ 50,000 $305,000 Less direct fixed expenses: Machine rent (5,000) (20,000) (50,000) (75,000) Supervision (15,000) (10,000) (20,000) (45,000) Depreciation (35,000) (10,000) (25,000) (70,000) Segment margin $120,000 $ 40,000 $ (45,000) $115,000 Hickory's management is deciding whether to keep or drop the parquet product line. Hickory's parquet flooring product line has a contribution margin of $50,000 (sales of $300,000 less total variable costs of $250,000). All variable costs are relevant. Relevant fixed costs associated with this line include 80% of parquet's machine rent and all of parquet's supervision salaries. In addition, assume that dropping the parquet product line would reduce sales of the strip line by 10% and sales of the plank line by 5%. All other information remains the same.
Required: 1. If the parquet product line is dropped, what is the contribution margin for the strip line? For the plank line?
Contribution Margin Strip line $
Plank line $
2. Which alternative (keep or drop the parquet product line) is now more cost effective? Keep the parquet product line By how much?
$
Explanation / Answer
1)Contribution Margin ratio For strip : contribution / sales
Strip : 175000/ 400000 = .4375 or 43.75%
Contribution margin for stip If saleS fall by 10% : 400000(1-.10)*.4375 = 157500
Plank : 80000/200000 = .40 or 40%
Contribution margin for Plank If sales fall by 5 % : 200000(1-.05)*.40 $ 76000
2)If Parguet product is division is dropped ,there will be no Contribution from it .However Fixed cost that will continued to be incurred includes [50000*.20]machine rent +[20000*.20 ]supervision
= 10000+4000+25000 = 39000
Net Operating loss from Parguet division : (39000)
Strip :157500-55000 fixed cost = 102500
Plank :76000- 40000 fixed cost : 36000
Total Operating income : 102500+36000+(39000)= 99500
since the segment margin has fallen from 115000 to 99500 (decrease net income by 15500 ) from dropping of product Parguet ,It should not be dropped
**80% of fixed cost of parguet is relevant means it is avoidable if not produced .so remaining 20% is not avoidable.