Question

Contemporary Trends sells paint and paint supplies carpet and wallpaper at a single store location in suburban Baltimore Although the company has been very profitable over the year management has seen very profitable over the year management has seen a significant decline in wallpaper sales and earnings Much of this decline is attributable to the internet and to companies that advertise deeply discounted prices in magazines and offer customer free shipping and toll free telephone number recent figures follow:

	Paint and supplies	Carpeting	wallpaper
Sales	190,000	230,000	70,000
Less variable cost	114,000	161,000	56,000
Fixed costs	28,000	37,500	22,000
Total cost	142,000	198,500	78,000
operating income	48,000	31,500	-8,000

Management is studying whether to drop wallpaper because of the changing market and accompanying loss if the line is dropped the following changes are expected to occur

1. The vacated space will be remodeled at a cost of 15,000 and will be devoted to an expanded line of high and carpet sales of carpet are expected to increase by 100,000        
2. Contemporary can cut wallpapers fixed costs by 50%                                  
3. Sales of paint and paint supplies are expected to fall by 30%                       
4. Considering (a), (b) and (c), explain your decision whether to drop or retain the wallpaper

Answer 1

Here, Variable cost for

Paint and supplies= 114000/19000*100 = 60%

Carpet=161000/230000*100 = 70%

Wallpaper=56000/70000*100= 80%

A. If the Vacated space will be converted into carpet sales area, then

Operating cost for carpets

= 330000 - 231000 - ( 37500 + 22000 ) = 39500

( Since sales of carpets will be increased by 1 lakh and Variable cost is 70%. Also, fixed cost for wallpaper manufacturing unit will be included in this carpet sales area.  )

B. If the fixed cost for wallpaper manufacturing area will be reduced to half, the profit for carpet business will increase by that amount , i.e., new operating profit will be 39500+11000=50500

C. if sales of paint will decline by 30%, then new operating income will be as follows

133000 - 79800 - 28000 = 25200

( 30% decline in sales will result in sales of 133000 and operating profit will decrease to 25200 after subtracting variable cost @60 % and fixed cost of 28000 )

D. revised statement after dropping wallpaper business will be

	Paint and supplies	Carpetting
Sales	133000	330000
Less :Variable cost	79800	231000
Less ;fixed cost	28000	48500
Total cost	107800	279500
Operating Profit	25200	50500

Total Profit = 75700

Since the new operating profit is higher than previous total of operating profit by 4200 ( 75700 - 71500 = 4200 ), I would suggest the idea of dropping wallpaper business.