The following information is for X Company\'s two products, A and B: $15,215 of

Question

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

$15,215 of Product A's fixed costs are avoidable; $33,034 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 $29,600. Accompanying the sales increase will be a fixed cost increase of $4,800. If X Company drops Product B and increases Product A sales, what will be the effect on firm profits?

Product A Product B Revenue $93,000    $90,000    Total contribution margin 39,990    37,800    Total fixed costs 30,430    55,990    Profit $9,560    $-18,190   

Explanation / Answer

Current Profit

= Product A + Product B

= $9,560 + $ - 18,190

= $ - 8,630

Except avoidable fixed costs, remaining fixed costs of ($55,990 - $33,034 = $22,956) cannot be avoided and have to be incurred in case of product B

Contribution margin ratio of product A

= Contribution / Sales

= $39,990 / $93,000

= 0.43 or 43%

The following table shows the calculations

New sales of product A

= Old + $29,600

= $93,000 + $29,600

= $122,600

New total fixed costs of product A

= Old + $4,800 + Unavoidable fixed costs of product B

= $30,430 + $4,800 + $22,956

= $58,186

So, the losses will reduce from $8,630 to $5,468 and so the proposal should be accepted

Calculations Particulars Product A Product B Total A + B A Sales     122,600                -            122,600 B Contribution margin ratio            0.43                -                       -   C = A x B Contribution       52,718                -              52,718 D Total Fixed costs       58,186                -              58,186 E = C - D Profit       (5,468)                -              (5,468)

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