Keep-or-Drop for Service Firm, Complementary Effects, Traditional Analysis Dever
ID: 2531265 • Letter: K
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:
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.
Required:
1. If Devern Assurance Company drops property insurance, by how much will income increase or decrease?
Decrease by $
As a supporting computation, prepare a segmented income statement for the keep-or-drop decision.
2. Assume that dropping all advertising for the property insurance line and increasing the corporate advertising budget by $450,000 will increase sales of property insurance by 10 percent and automobile insurance by 8 percent. Prepare a segmented income statement that reflects the effect of increased advertising.
PropertyInsurance Automobile
Insurance Sales $4,200,000 $12,000,000 Less variable expenses 3,830,000 9,600,000 Contribution margin $370,000 $2,400,000 Less direct fixed expenses 400,000 500,000 Segment margin $(30,000) $1,900,000 Less common fixed expenses (allocated) 100,000 200,000 Operating income (loss) $(130,000) $1,700,000
Explanation / Answer
SOLUTION
(A)
According the statements above, if the company droped property insurance, its income will decrease by $258,000. So, the company should Not drop property insurance.
(B)
The income will increase by $179,000, So, advertising should be increased.
With property insurance ($) Without property insurance ($) Total Sales 16,200,000 10,560,000 Less: Variable expense 13,430,000 8,448,000 Contribution margin 2,770,000 2,112,000 Less: Direct fixed expense 900,000 500,000 Segment margin 1,870,000 1,612,000 (258,000)Related Questions
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