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Jamison Health Care is trying to decide if it should eliminate its orthopedic care division
Jamison Health Care is trying to decide if it should eliminate its orthopedic care division. Last year, the orthopedic division had a total contribution margin of $100,000 and allocated overhead costs of $200,000, of which $90,000 could be eliminated if the division were dropped.
On the information given, should Jamison keep the division?
And what other considerations could override a strictly financial analysis to make the decision?
Expert Solution
In the given case the allocated OH cost of $110,000 (= 200,000 - 90,000) is fixed thus is a sunk cost and should not impact on our decision. We need to make a comparison of total contribution margin of $100,000 or saving $90,000 that can be eliminated. Thus,
|
Contribution Margin |
$100,000 |
|
Minus: Avoidable Fixed Costs |
$90,000 |
|
Net benefit |
$10,000 |
As we have computed a net gain of $10,000 when the orthopedic care division operates, thus we should continue operating orthopedic care division because dropping it would not give us more saving.
The main consideration to override a strictly financial analysis are the relevant costs and avoidance of irrelevant cost to make sound business decisions on rejecting or accepting a special order, buying a product from outside or making in-house, selling a processed product or semi-finished, and shutting down or carrying on a division in business.
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