Question

Galley, Inc. manufactures two product lines, toasters and blenders. Below is the most recent contribution margin segmented income statement prepared by Galley’s accountant, who allocated common fixed costs between the two segments based on sales revenue.
Total    Toasters Blenders
Sales $ 1,000,000 $ 450,000 $ 550,000
Variable costs 745,000 300,000 445,000
Contribution margin 255,000 150,000 105,000
Traceable fixed costs (80,000) (25,000) (55,000)
Segment margin $175,000 $125,000 $50,000
Common fixed costs (40,000) (18,000) (22,000)
Operating income (loss) $135,000 $107,000 $28,000

Galley plans to discontinue the production of blenders and use the freed-up capacity to double the production and sales of toasters. If blenders are discontinued, Galley will avoid half of the fixed costs traceable to the blender product line. On the other hand, doubling production of toasters will increase the fixed costs traceable to the toaster product line by $35,000. What would be the impact on Galley’s operating income of discontinuing the blender product line?

Answer 1

Galley operating income after discontinuing Blenders segment.

Toasters

Contribution margin = 450,000*2 = 900,000

Traceable fixed cost = 25,000 + 35,000 + 27,500 (half of belnders) = 87,500

Common fixed cost = 18,000 + 22,000 = 40,000

Operating income = 900,000 - 87,500 - 40,000

= $ 772,500

Therfore the operating income will increase by = 772,500 - 135,000

= $ 637,500

I have assumed that common fixed cost of belnders will be liable to incurr.

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