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 25% 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?
$

For the plank line?
$

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

Answer 1

1
Contribution margin for the strip line	131250	=175000*(1-25%)
Contribution margin For the plank line	64000	=80000*(1-20%)
2
Loss in Contribution margin of Parquet	-50000
Loss in Contribution margin of Strip	-43750	=131250-175000
Loss in Contribution margin of Plank	-16000	=64000-80000
Avoidable machine rent	24000	=30000*80%
Avoidable supervision salaries	5000
Net change in income	-80750
Keep by $ 80750