Question

Q1) The income statement for Sweet Dreams Company is divided by its two product lines, blankets and pillows, as follows:

	Blankets	Pillows	Total
Sales revenue	$620,000	$300,000	$920,000
Variable expenses	465,000	240,000	705,000
Contribution margin	155,000	60,000	215,000
Fixed expenses	76,000	76,000	152,000
Operating income (loss)	$79,000	$(16,000)	$63,000

Required:

a) If Sweet Dreams can eliminate fixed costs of $50,000 by dropping the pillow line, should it be dropped? Explain

b) If Sweet Dreams can eliminate fixed costs of $50,000 and increase the sale of blankets by 3,000 units at a selling price of $20 per unit and a contribution margin of $5 per unit, should it be dropped? Explain

Q2) Lowwater Sailmakers manufactures sails for sailboats. The company has the capacity to produce 25,000 sails per year, but is currently producing and selling 20,000 sails per year. The following information relates to current production:

Sale price per unit	$150
Variable costs per unit:
Manufacturing	$55
Marketing and administrative	$25
Total fixed costs:
Manufacturing	$640,000
Marketing and administrative	$280,000

1.         If a special sales order is accepted for 5,000 sails at a price of $125 per unit, and fixed costs remain unchanged, how would operating income be affected? (NOTE: Assume regular sales are not affected by the special order.)

      A.        Decrease by $5,000

      B.         Increase by $190,000

      C.         Decrease by $125,000

      D.        Increase by $225,000

2.      If a special sales order is accepted for 2,000 sails at a price of $95 per unit, and fixed costs increase by $10,000, how would operating income be affected? (NOTE: Assume regular sales are not affected by the special order.)

      A.        Decrease by $34,000

      B.         Decrease by $44,000

      C.         Increase by $20,000

      D.        Increase by $25,000

3.      If a special sales order is accepted for 2,500 sails at a price of $70 per unit, fixed costs increase by $10,000, and variable marketing and administrative costs for that order are $5 per unit lower than on regular sales, how would operating income be affected? (NOTE: Assume regular sales are not affected by the special order.)

A.           Decrease by $22,500

B.            Decrease by $82,500

C.            Increase by $10,000

D.           Increase by $22,500

4.      If a special sales order is accepted for 3,000 sails at a price of $75 per unit, fixed costs remain unchanged, and no variable marketing and administrative costs will be incurred for this order, how would operating income be affected? (NOTE: Assume regular sales are not affected by the special order.)

      A.        Decrease by $5,000

      B.         Decrease by $15,000

      C.         Increase by $35,000

      D.        Increase by $60,000

Answer 1

Q1)
a) If sweet dream discontinue sales of Pillow then variable expemses of pillow department will be zero. And fix cost will reduce by 50000 i.e. it will reduced to 16000. Hence there will still be a loss of 16000.
Hence it is indifferent for the company to condinue or discontinue pillow department.

b) Yes, it should stop pillow sale in this case.
As it will lead to increase in sales of blanket by 3000 units, which will generate extra contribution of $15000.
And there is still excess fix cost of $16000. Hence net loss will reduce to $1000.

Q2)
1. D) increase by $225000

2. C) increase by $20000

3. A) Decrease by $22500

4. D) increase by $60000