Question

Structuring a Keep-or-Drop Product Line Problem with Complementary Effects

Shown below is a segmented income statement for Hickory Company's three wooden flooring product lines:

	Strip		Plank		Parquet		Total
Sales revenue	$400,000		$200,000		$300,000		$900,000
Less: Variable expenses	225,000		120,000		250,000		595,000
Contribution margin	$175,000		$ 80,000		$ 50,000		$305,000
Less direct fixed expenses:
Machine rent	(5,000)		(20,000)		(30,000)		(55,000)
Supervision	(15,000)		(10,000)		(5,000)		(30,000)
Depreciation	(35,000)		(10,000)		(25,000)		(70,000)
Segment margin	$120,000		$ 40,000		$ (10,000)		$150,000

Hickory's management is deciding whether to keep or drop the parquet product line. Hickory's parquet flooring product line has a contribution margin of $50,000 (sales of $300,000 less total variable costs of $250,000). All variable costs are relevant.

Relevant fixed costs associated with this line include 80% of parquet's machine rent and all of parquet's supervision salaries. In addition, assume that dropping the parquet product line would reduce sales of the strip line by 21% and sales of the plank line by 20%. All other information remains the same.

Required:

1. If the parquet product line is dropped, what is the contribution margin for the strip line?

2. Which alternative (keep or drop the parquet product line) is now more cost effective and by how much?

Answer 1

Answer is given below