Keep-or-Drop for Service Firm, Complementary Effects, Traditional Analysis Dever

Question

Keep-or-Drop for Service Firm, Complementary Effects, Traditional Analysis Devern Assurance Company provides both property and automobile insurance. The projected income statements for the two products are as follows: Property Automobile Insurance Insurance $4,200,000 3,830,000 $370,000 400,000 (30,000) 100,000 $(130,000) $12,000,000 9,600,000 $2,400,000 500,000 1,900,000 200,000 $1,700,000 Sales Less variable expenses Contribution margin Less direct fixed expenses Segment margin Less common fixed expenses (allocated) Operating income (loss) The president of the company is considering dropping the property insurance. However, some policyholders prefer having their property and automobile insurance with the same company, so if property insurance is dropped, sales of automobile insurance will drop by 12 percent. No significant non-unit-level activity costs are incurred.

Explanation / Answer

The income is increased by $1,79,000

So advertising should be increased.

Segmented Income statement Property insurance Automobile Insurance Total Sales $4,620,000 $12,960,000 $17,580,000 (-)variable cost ($4,213,000) ($10,368,000) ($14,581,000) Contribution $4,07,000 $2,592,000 $2,999,000 (-)direct fixed costs - ($5,00,000) ($5,00,000) Segmented margin $407,000 $2,092,000 $2,499,000 (-)common fixed cost ($7,50,000) operating income $1,749,000

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