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	$	225,000		$	280,000
Variable costs:
Cost of goods sold		75,000			140,000
Selling & administrative		37,500			55,000
Contribution margin	$	112,500		$	85,000
Fixed expenses:
Fixed corporate costs		65,000			80,000
Fixed selling and administrative		17,000			26,000
Total fixed expenses	$	82,000		$	106,000
Operating income	$	30,500		$	(21,000	)

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 $47,000? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).)

1.	Net income on discontinuing T-2 or Net loss ? (choose 1)
2.	Required % increase in sales of T-1		%
3.	Required % increase in sales from T-1		%

Answer 1

Part 1.

If T2 is dropped and the company sells only T1:

	T1
Sales ($225000*110%)	$247500
Variable Cost of Goods Sold ($75000*110%)	$82500
Variable Selling & Administration (16.66667% of Sales)	41250
Contribution Margin	$123750
Expenses:
Fixed Corporate Costs ($65000+$80000)	$145000
Fixed Selling & Administration	$43000
Total fixed Expense	$188000
Operating Income/(Loss)	($64250)

Net loss on discontinuing T-2 = 64250 +9500 = 73750

Net loss on discontinuing T-2 = (73750)

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

Loss of contribution margin T2 = Gain in contribution margin T1

85000 = 112500 * contribution %

contribution % = 85000 / 112500 = 75.56%

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

Loss of contribution margin T2 - fixed expenses = Gain in contribution margin T1

85000 - 47000 = 112500 * contribution %

contribution % = 38000 / 112500 = 33.78%