Question

The following are the budgeted profit functions for X Company's two products, A and B, next year:

Product A:   P = .45 (R) - $58,720

Product B:   P = .42 (R) - $26,420

where R is revenue. Budgeted revenue for the two products are $86,000 and $93,000, respectively. Unavoidable fixed costs for the two products are $21,726 and $11,889, respectively. The company is considering dropping Product A; if it does, the resulting freed-up resources can be used to increase revenue from sales of Product B by $18,300, with no additional fixed costs.

1. If X Company drops A and increases revenue from B, firm profits will change by________

Answer 1

Solution:

Firm's Profit if Both products continued:

Product A = .45*(86000) - $58720 = -$20,020 (Loss)

Product B = .42*(93000) - $26420 = $12,640 (profit)

Loss of Firm = -$20020 + $12640 = -$7,380

Firm's Profit if Product A is dropped and Revenue from B is increased:

Product A = - $21726 (Loss of unavoidable fixed cost as this product is dropped)

Product B:

Increased Revenue = $93000 + $18300 = $111,300

Profit from Product B = .42*(111300) - $26420 = $20,326

Loss of Firm = -$21726 + $20326 = - $1400

Therefore,

Change in Firm's Profit = - $1400 - (-$7380) = -$1400 + $7380 = $5,980 (Increse)

Hence firm's profir will increase by $5,980.