Question

Barbour Corporation, located in Buffalo, New York, is a retailer of high-tech products and is known for its excellent quality and innovation. Recently, the firm conducted a relevant cost analysis of one of its product lines that has only two products, T-1 and T-2. The sales for T-2 are decreasing and the purchase costs are increasing. The firm might drop T-2 and sell only T-1.

Barbour allocates fixed costs to products on the basis of sales revenue. When the president of Barbour saw the income statements (see below), he agreed that T-2 should be dropped. If T-2 is dropped, sales of T-1 are expected to increase by 10% next year, but the firm’s cost structure will remain the same.

	T-1			T-2
Sales	$	250,000		$	300,000
Variable costs:
Cost of goods sold		80,000			150,000
Selling & administrative		32,500			60,000
Contribution margin	$	137,500		$	90,000
Fixed expenses:
Fixed corporate costs		70,000			85,000
Fixed selling and administrative		22,000			31,000
Total fixed expenses	$	92,000		$	116,000
Operating income	$	45,500		$	(26,000	)

Required:

1. Find the expected change in annual operating income by dropping T-2 and selling only T-1.

2. By what percentage would sales from T-1 have to increase in order to make up the financial loss from dropping T-2? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).)

3. What is the required percentage increase in sales from T-1 to compensate for lost margin from T-2, if total fixed costs can be reduced by $54,500? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).)

1.Net loss on discontinuing T-2

2.Required % increase in sales of T-1%

3.Required % increase in sales from T-1%

Answer 1

Answers:

1)

		T1	T2
1	sales	$250000	$300000
2	variable cost of goods sold	$80000	$150000
3	variabke selling and administration	$32500	$60000
4	Contribution Margin(1-2-3)	$137500	$90000

Contribution margin ratio = contribution margin/sales

T1 = 137500/250000×100 =55%

T2 = 90000/300000×100 = 30%

Incremental contribution margin from T1 if T2 is dropped(137500×10%) = $13750

Net effect of discontdiscontinuing T2(90000-13750) =$76250

2)

Loss of contribution margin T2 = Gain on contribution margin T1

$90000=$137500×X%

X = 90000/137500×100

X = 65.45%

3)

Loss of contribution margin T2 = Gain on contribution Margin T1

$90000-$54500 =$137500×X%

$35500 =$137500×X%

X = 35500/137500×100

X=25.82%