On Call, Dan owns a video shop in San Francisco. He is considering dropping a li

Question

On Call, Dan owns a video shop in San Francisco. He is considering dropping a line of videos (comedies). which has to Below are the inceme statements for Dan's three lines of videos: consistently had an operating loss Total Drama Action Comedy Sales Variable Costs 7,900 4,800 3,100 2,250 5,000 3,500 1.900 1,000 300 750 (50) 750 750 150 Fxed costs relate to the amount of space that is used in the video store. Given constraints on his ability to sell videos, Dan cannot use this space for anything else. In other words, Dan can only sell videos and can't use the space for other things. should Dan close the comedy section? Support your answer with calculations and discussion Now, suppose that if he replaced the comedy with additional drama or action, he could get $1,000 in additional drama or action revenue. The contribution mar percentages would be the same as in the first case. Using opportunity cost concepts, should Dan replace comedy with either drama or action fil ms?

Explanation / Answer

1)If comedy section is closed There will be not contribution from this section .however fixed cost allocated to this section will continue to be incurred as it is an allocated cost and company has no alternative use of it.

So Net loss from comedy section if it is dropped =contribution -fixed cost

                  = 0- 750

                  = - 750

So overall company total Income =Income fromdrama +income from action +income from comedy

      = 750+150-750

      = 150

since the overall company income falls with drop of comedy section ,comedy section should not be dropped.

2)Contribution margin ratio of drama division = contribution /sales

             = 1500/5000

             = .30 or 30%

With increase in $ 1000sales due to close of comedy division ,it will generate incremental contribution of 1000*.30 = $ 300

Contribution margin ratio of action =900/1900=.4737 or 47.37%

With increase in $ 1000sales due to close of comedy division ,it will generate incremental contribution of 1000*.4737 = $ 473.7   [rounded to 474]

If comedy section is discontinued

[1500+300 ]drama+900 action -2250 fixed c ost

=450

1500 drama +[900+474]action -2250

=624

since the highest income is when comedy section is continued ,it should not be dropped (not to be substitued with action or drama division )

If comedy section is discontinued If comedy section is continued Idle facility not used Increase in drama Increase in action revenue Total Income of company 850 150 [calculated in part 1]

[1500+300 ]drama+900 action -2250 fixed c ost

=450

1500 drama +[900+474]action -2250

=624

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