Diego Company manufactures one product that is sold for $78 per unit in two geog

Question

Diego Company manufactures one product that is sold for $78 per unit in two geographic regions—the East and West regions. The following information pertains to the company’s first year of operations in which it produced 49,000 units and sold 44,000 units.

Variable costs per unit:
Manufacturing:
Direct materials$28
Direct labor$14
Variable manufacturing overhead$4
Variable selling and administrative$6
Fixed costs per year:
Fixed manufacturing overhead$686,000
Fixed selling and administrative expenses$510,000

The company sold 32,000 units in the East region and 12,000 units in the West region. It determined that $230,000 of its fixed selling and administrative expenses is traceable to the West region, $180,000 is traceable to the East region, and the remaining $100,000 is a common fixed cost. The company will continue to incur the total amount of its fixed manufacturing overhead costs as long as it continues to produce any amount of its only product.

Diego is considering eliminating the West region because an internally generated report suggests the region’s total gross margin in the first year of operations was $14,000 less than its traceable fixed selling and administrative expenses. Diego believes that if it drops the West region, the East region's sales will grow by 5% in Year 2. Using the contribution approach for analyzing segment profitability and assuming all else remains constant in Year 2, what would be the profit impact of dropping the West region in Year 2?

How much will the profit increase/decrease by?

Assume the West region invests $39,000 in a new advertising campaign in Year 2 that increases its unit sales by 20%. If all else remains constant, what would be the profit impact of pursuing the advertising campaign?

How much will the profit increase/decrease by?

Explanation / Answer

Existing scenario Net income: East Region West Region Total Units sold 32000 12000 44000 Sales at $78 per unit 2496000 936000 3432000 Less: Variable cost Direct materials at $28 per unit 896000 336000 1232000 Direct labor at $14 per unit 448000 168000 616000 Variable manufacturing overhead At $4 per unit 128000 48000 176000 Variable selling and administrative At $6 per unit 192000 72000 264000 1664000 624000 2288000 Contribution margin 832000 312000 1144000 Less:Fixed selling & admin expense 230000 180000 410000 Gross margin 602000 132000 734000 Less:Common expenses Fixed selling & admin expense 100000 Fixed manufacturing overhead 686000 Net loss -52000 If we drop West region: Net income: Units sold (32000*1.05) 33600 Sales at $78 per unit 2620800 Less: Variable cost Direct materials at $28 per unit 940800 Direct labor at $14 per unit 470400 Variable manufacturing overhead At $4 per unit 134400 Variable selling and administrative At $6 per unit 201600 1747200 Contribution margin 873600 Less:Fixed selling & admin expense 230000 Gross margin 643600 Less:Common expenses Fixed selling & admin expense 100000 Fixed manufacturing overhead 686000 Net loss -142400 If we drop west region,company's overll profit will decrease by $90400 (142400-52000) If west region invest in new advertising campaign, East Region West Region Total Units sold 32000 14400 44000 (12000*1.20) Sales at $78 per unit 2496000 1123200 3619200 Less: Variable cost Direct materials at $28 per unit 896000 403200 1299200 Direct labor at $14 per unit 448000 201600 649600 Variable manufacturing overhead At $4 per unit 128000 57600 185600 Variable selling and administrative At $6 per unit 192000 86400 278400 1664000 748800 2412800 Contribution margin 832000 374400 1206400 Less:Fixed selling & admin expense 230000 219000 449000 (180000+39000) Gross margin 602000 155400 757400 Less:Common expenses Fixed selling & admin expense 100000 Fixed manufacturing overhead 686000 Net loss -28600 If west region invest in new advertising campaign, overall profit will increase by $23400 (52000-28600)

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