Question

Healthy Ltd has two product lines: Basic and Premium. Business costs have been divided roughly into their variable and fixed elements. The business is considering whether to drop one of the product lines. The following financial information about each of the product line has been provided:

	Basic line	Premium line	Total
Sales revenue	$100,000	$80,000	$180,000
Less Cost of goods sold	($20,000)	($32,000)	($52,000)
Less Other variable costs	($10,000)	($12,000)	($22,000)
Contribution Margin	$70,000	$36,000	$106,000
Less Avoidable fixed costs	($25,000)	($6,000)	($31,000)
Less Unavoidable fixed costs	($5,000)	($20,000)	($25,000)
Profit	$40,000	$10,000	$50,000

Question: If the business drops Premium product line, what will happen to total profit?

-Total profit will reduce by $45,000.

-Total profit will reduce by $30,000.

-Total profit will reduce by $62,000.

-Total profit will reduce by $10,000.

Answer 1

Option b i.e. Total profit will reduce by $30,000 is the correct answer.

Explanation:

Unavoidable fixed costs are the cost that can not be avoided even if the product line is closed.

All the other revenue and costs can be avoided except the unavoidable cost if the product line is dropped.

In the given case if the premium product line is closed, the company will lose all the revenue and costs but will continue to spend to spend the unavoidable fixed costs of $20,000.

So if the premium line is closed, the loss of the company will be = $20,000 i.e. unavoidable fixed cost.

So change in profit = Profit if product line is continued - Profit if product line is dropped

So change in profit = $10,000 - ($20,000) = $30,000.