The following information is for X Company\'s two products, A and B: $14,835 of
ID: 2452961 • Letter: T
Question
The following information is for X Company's two products, A and B:
$14,835 of Product A's fixed costs are avoidable; $33,602 of Product B's fixed costs are avoidable. X Company plans to drop Product B since it shows a loss and increase sales of Product A by $31,200. Accompanying the sales increase will be a fixed costs increase of $4,400.
1) If X Company drops Product B and increases Product A sales, what will be the effect on firm profits?
Product A Product B Revenue $86,000 $93,000 Total contribution margin 36,120 39,060 Total fixed costs 27,990 58,950 Profit $8,130 $-19,890Explanation / Answer
Variable costs are always avoidable and Fixed costs has two components. One is un avoidable that is it will be done even if the product is not produced and the other one is avoidable that is it will be saved if the product is not produced.
The total benefit of dropping product B will be decided when we will add total savings and compare it with increase in expenses due to increase in production of product A
Contribution Margin ratio for both the products is calculated as follows:
Product A Contribution Margin
= Total contribution margin/Revenue
= (36,120/86,000) X 100
= 42 %
By increasing sales of Product A, the Net benefit will be calculated as follows:
Net benefit
= Contribution from increased Sales - Increase in Fixed costs
= $ 31,200 X 42% - $ 4,400
= $ 13,104 - $ 4,400
= $ 8,704
Total increase in Firm's profits will be as follows:
Total increase = Net benefit from producing additional units of product A + Savings in avoidable fixed cost of product B
= $ 8,704 + $33,602
= $ 42,306
So, If X Company drops Product B and increases Product A sales, the profits of the company will increase by
$ 42,306.
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