The following information is for X Company\'s two products, A and B: 7. If X Com

Question

The following information is for X Company's two products, A and B:

7. If X Company drops Product A because it shows a loss, what will be the effect on firm profits?

8. Assume that if X Company drops Product A, it can use the vacant space to increase sales of Product B by $30,200, but $4,000 of additional fixed costs will be incurred. This use of the vacant space will result in an increase in X Company's profits of

Product A Product B Revenue $87,000    $95,000    Total variable costs   51,330      56,050    Total contribution margin $35,670    $38,950    Total fixed costs    Avoidable 30,784    17,004       Unavoidable   25,186      15,696    Profit $-20,300    $6,250   

Explanation / Answer

7) If product A is dropped, the X company will not be able to recover even the Unavoidable fixed cost and that portion of unavoidable fixed costs will get apportioned to product B.

Current profits = $6,250 - $20,300 = - $14,050

Expected profit due to dropping of A = $6,250 - $25,186 (unavoidable fixed cost) = - $18,936

So, the loss will increase by $ 4,886

8)

Contribution margin ratio of B = Contribution / Sales = $38,950 / $95,000 = 41%

Excess contribution from sales of $30,200 of B = $30,200 x 41% = $12,382

Net benefit = Contribution - additional fixed cost = $12,382 - $4,000 = $8,382

So, the company's profits will increase by $8,382.

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