Structuring a Keep-or-Drop Product Line Problem with Complementary Effects Shown

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:

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?

2. Which alternative (keep or drop the parquet product line) is now more cost effective?
Keep the parquet product line

By how much?
$

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

Explanation / Answer

Answer 1. Parquet Product line is Dropped. Contribution Margin: Strip Line - $175,000 X 90%          157,500 Planl Line - $80,000 X 95%            76,000 Answer 2. Statement of Incremental Profit (Loss) If Parquet Product Line is dropped Incremental Revenue: Saving in Fixed Costs: Machine Rent - $50,000 X 80%            40,000 Supervision Salary            20,000      60,000 Incremental Cost Loss of Contribution: Parquet - 100%            50,000 Strip - $175,000 X 10%            17,500 Plank - $80,000 X 5%              4,000      71,500 Net Incremental Profit (Loss)    (11,500) Keep the Parquet product Line.

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