A company wants to add a new line to an already profitable business. Research in

Question

A company wants to add a new line to an already profitable business. Research indicates that the new line would generate $30,000 in revenue when 25,000 units are produced. If added net income would... a. Increase $3750 b. Increase $8750 c. Decrease $2500 d. Decrease $3250 e. None of the above $0.85/unit $5,000 Indirect fixed cost that is currently in place (unavoidable) $6,250 Variable cost Additional Direct Cost (avoidable) Cecil Company has 3 products stamps, paper, and ribbons. And while the business is profitable overall, they are losing money on the stamps line. If Cecil Company abandons stamps, net ncome would.. a. b. c. d. e. Increase $3,000 Decrease $3,000 Decrease $6,000 Decrease $8,000 None of the above Sales Revenue Variable Cost Direct Fixed Cost (avoidable) Indirect Fixed cost allocated from other parts of business Net Income (loss) $27,000 $19,000 $5,000 $6,000 ($3,000)

Explanation / Answer

Part 1

Correct Answer----- (a) Increase $3750

Explanation and Calculations

Statement of Cost and Benefit

Additional Revenue

$ 30,000.00

Less: Variable cost (0.85x25000)

$ 21,250.00

Contribution Margin

$    8,750.00

Avoidable fixed cost

$    5,000.00

Net income

$    3,750.00

Indirect fixed cost will not be considered for this decision because indirect fixed cost is unavoidable hence irrelevant.

Part 2

Correct Answer-----(b) Decrease $ 3000

Statement of Cost and Benefit

Sales revenue

$ 27,000.00

variable Cost

$ 19,000.00

Contribution Margin

$    8,000.00

Direct Fixed cost(Avoidable)

$    5,000.00

Net benefit

$    3,000.00

Let’s understand this part clearly

We can see in the above statement that Indirect fixed cost is not taken into consideration because that is an unavoidable cost.

Unavoidable cost is not considered for decision making because this cost occurs no matter what decision is taken .

If we say that Stamps are abandoned then 6000 cost will be assigned to other products but in total indirect fixed cost will remain change.

Now we understand that only avoidable cost matters. We can see above that company is still making $ 3000 from stamps. If stamps are abandoned there will be decrease in income of $3000.   

Statement of Cost and Benefit

Additional Revenue

$ 30,000.00

Less: Variable cost (0.85x25000)

$ 21,250.00

Contribution Margin

$    8,750.00

Avoidable fixed cost

$    5,000.00

Net income

$    3,750.00

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