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Mechum River Anglers, a division of Old Dominion Travel, offers two types of guided fly fishing tours, Basic and Deluxe
Mechum River Anglers, a division of Old Dominion Travel, offers two types of guided fly fishing tours, Basic and Deluxe. Operating income for each tour type in
2014 is as follows:
Basic Deluxe
Revenues (500 * $900; 400 * $1,650) $450,000 $ 660,000
Operating costs
Administrative salaries 120,000 100,000
Guide wages 130,000 380,000
Supplies 50,000 100,000
Depreciation of equipment 25,000 60,000
Vehicle fuel 30,000 24,000
Allocated corporate overhead 45,000 66,000
Total operating costs 400,000 730,000
Operating income (loss) $ 40,000 $ (70,000)
The equipment has a zero disposal value. Guide wages, supplies, and vehicle fuel are variable costs
with respect to the number of tours. Administrative salaries are fixed costs with respect to the number of
tours. Brad Barrett, Mechum River Anglers’ president, is concerned about the losses incurred on the deluxe
tours. He is considering dropping the deluxe tour and offering only the basic tour.
1. If the deluxe tours are discontinued, one administrative position could be eliminated, saving the company $50,000. Assuming no change in the sales of basic tours, what effect would dropping the deluxe tour have on the company’s operating income?
2. Refer back to the original data. If Mechum River Anglers drops the deluxe tours, Barrett estimates that sales of basic tours would increase by 50%. He believes that he could still eliminate the $50,000 administrative position. Equipment currently used for the deluxe tours would be used by the additional basic tours. Should Barrett drop the deluxe tour? Explain.
3. What additional factors should Barrett consider before dropping the deluxe tours?
Expert Solution
Answer.
Solution 1.
Brad Barrett must not drop the deluxe tours, as follows:
Lost revenues from deluxe tours $(660,000)
Avoidable operating costs from dropping deluxe tours:
Administrative salaries 50,000
Guide wages 380,000
Supplies 100,000
Vehicle fuel 24,000
Total avoidable costs 554,000
Lost operating income from dropping deluxe tours $(106,000)
Note: Equipment depreciation, allocated corporate costs, and unavoidable administrative salaries are irrelevant for the decision.
Solution 2.
Barrett should drop the deluxe tours, as follows:
| Basic | Deluxe | Total | |
| $225,000 | ($660,000) | -435,000 | |
| Adm salaries | 0 | -50,000 | -50,000 |
| Guide Wages | 65000 | -380,000 | -315000 |
| Supplies | 25000 | -100,000 | -75000 |
| Vehicle Fuel | 15000 | -24,000 | -9000 |
| Changes in revenues | 105000 | -554,000 | -449000 |
| Change in operating costs | $120,000 | ($106,000) | $14,000 |
| Total change in operating costs | $14,000 |
Solution 3.
Barrett must first of all consider that if it is possible to enhance the number of deluxe tours sold, or whether it is possible to diminish the costs of such tours before the idea of dropping them. He can also search upon the chances of increasing the rates of deluxe tours if customers can bear it.
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