Mohave Corp.see (PA7-1 and PA7-2) is considering eliminating a product from its

Question

Mohave Corp.see (PA7-1 and PA7-2) is considering eliminating a product from its Sand Trap line of beach umbrellas. This collection is aimed at people who spend time on the beach or have an outdoor patio near the beach. Two products, the Indigo and Verde umbrellas, have impressive sales. However, sales for the Azul model have been dismal. ? Mohaves information related to the Sand Trap line is shown below. Segmented Income Statement for Mohaves Sand Trap Beach Umbrella Products Indigo Verde Azul Total Sales revenue $ 60,000 $ 60,000 $ 30,000 $ 150,000 Variable costs 34,000 31,000 26,000 91,000 Contribution margin $ 26,000 $ 29,000 $ 4,000 $ 59,000 Less: Direct Fixed costs 1,900 2,500 2,000 6,400 Segment margin $ 24,100 $ 26,500 $ 2,000 $ 52,600 Common fixed costs* 17,840 17,840 8,920 44,600 Net operating income (loss) $ 6,260 $ 8,660 $ (6,920) $ 8,000 *Allocated based on total sales dollars. ? Mohave has determined that eliminating the Azul model would cause sales of the Indigo and Verde models to increase by 10 percent and 15 percent, respectively. Variable costs for these two models would increase proportionately. Although the direct fixed costs could be eliminated, the common fixed costs are unavoidable. The common fixed costs would be redistributed to the remaining two products.

Required.

1 Will Mohawk corp net operating increase or decrease if azul model is eliminated by how much?

2. Should Mohave drop the azul model?

3. Suppsed that mohave had no direct fixed overhead in ts production information and the entire $ 51,000 of fixed cost was common fixed cost. Would your reccommedation to mohave change? Why or why not?

See both charts below to help with answers.

PA7-1

PA7-2

Direct material $ 5.00 Direct labor 2.00 Variable manufactured overhead 3.50 Fixed manufacture overhead 2.50 Total cost =13.00 Regular sales price $ 19.00

Explanation / Answer

1)

Income statement before dropping the brand Azul:

Income Statement when Azul is dropped from the product line.

2) Above calculation shows that on dropping Azul, the net operating income of the company will increase by

$12950 - $8000 = $4950.

So it is recommended to drop the brand Azul.

3)

If there is no direct cost and the entitr $51000 is common fixed cost, the net operating income will not change if the company runs with the three model as before as shown below.

But if the change in the production schedule is effected the net operating income will increase by $10950 - $8000 = $2950 as shown below:

Therefore even when the entire $51000 will be treated as the common fixed cost, the profit will still increase by $2950 if the brand Azull is dropped from the production line.

Hence Azul should be dropped.

Products Indigo($) Verde($) Azul($) Total ($) Sales 60000 60000 30000 150000 Variable Cost -34000 -31000 -26000 -91000 contribution 26000 29000 4000 59000 Less: Direct Fixed costs -1900 -2500 -2000 -6400 common fixed costs -17840 -17840 -8920 -44600 net operating income or loss 6260 8660 -6920 8000

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