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A retail furniture company currently sells products in four categories; recliners, sofas, dining sets, and patio
A retail furniture company currently sells products in four categories; recliners, sofas, dining sets, and patio.
Due to recent poor performance, the company is considering eliminating the patio furniture line.
| Recliners | Sofas | Dining | Patio | |
|---|---|---|---|---|
| Sales | $500,000 | $700,000 | $900,000 | $400,000 |
| Variable expenses | 200,000 | 375,000 | 405,000 | 330,000 |
| Allocated fixed expenses | 200,000 | 280,000 | 360,000 | 160,000 |
| Operating income | $100,000 | $45,000 | $135,000 | $(90,000) |
If patio furniture is eliminated, 80% of the fixed costs assigned to the product line could be avoided. The company does experience cross-sales opportunities and estimates eliminating the patio furniture will lead to a 5% decrease in unit sales of each of the other three product line.
The company should
A. Eliminate the patio furniture line, which will increase the company's operating income by $2,000.
B. Keep the patio furniture line because eliminating it will decrease the company's operating income by $67,000.
C. Eliminate the patio furniture line, which will increase the company's operating income by $38,000.
D. Keep the patio furniture line because eliminating it will decrease the company's operating income by $94.000.
Expert Solution
Correct answer: Option A) Eliminate the patio furniture line, which will increase the company's operating income by $2,000.
Explanation:
The first step is to determine the contribution margin of each product:
| Recliners | Sofas | Dining | Patio | |
|---|---|---|---|---|
| Sales | $500,000 | $700,000 | $900,000 | $400,000 |
| Variable expenses | 200,000 | 375,000 | 405,000 | 330,000 |
| Contribution margin | $300,000 | $325,000 | $495,000 | $70,000 |
The second step is to determine the net benefit:
If patio is discontinued:
| Amount | |
| Savings in fixed costs ($160,000 * 80%) | $128,000 |
| Lost contribution margin from Patio | ($70,000) |
| Lost contribution margin from the other three units (($300,000 + $325,000 + $495,000) * 5%) | ($56,000) |
| Net benefit/ Increase in overall operating income | $2,000 |
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