Music Makers Company, a wholesale distributor, is considering discontinuance of

Question

Music Makers Company, a wholesale distributor, is considering discontinuance of its line of CDs due to stiff competition from MP3 downloads and other new, technologically advanced recordings. The variable cost of its CDs last year was about 40 percent of its CD revenue, and the allocated fixed cost equaled $100,000 per year. Last year’s sales were $250,000, but it is expected that in the future, annual revenue will drop by 20 percent and variable costs will rise to 50 percent of revenue (because of price reductions). Will CDs still be profitable for the company?

Please show and explain work.

Explanation / Answer

No it is not profitable as the profit gets reduced to -100,000,

Year 1,TR = 250000

VC = 0.4*250000= 100000

TC = FC+VC = 100000+100000 = 200000

Profit = TR-TC = 250000-200000 = 50000

Year 2,

TR= 250000-0.2*250000 = 200000

VC = 100000+200000*0.5=200000

FC = 100000

TC = 300000

Profit = -100000

TR FC VC TC profit Year 1 250000 100000 100000 200000 50000 Year 2 200000 100000 200000 200000 -100000

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