Question

The following income statement is for X Company's two products, A and B:

			Product A	Product B
Revenue			$95,000	$92,000
Total variable costs			52,250	55,200
Total contribution margin			$42,750	$36,800
Total fixed costs
Avoidable			30,934	13,854
Unavoidable			23,336	12,286
Profit			$-11,520	$10,660

If X Company drops Product A because it shows a loss and is able to use the vacant space to increase sales of Product B by $31,700, with $4,800 of additional fixed costs, what will be the effect on firm profits?

A: $-2,519

B: $-3,149

C: $-3,936

D: $-4,920

E: $-6,150

F: $-7,688

Answer 1

· Calculation of effect on profits:
>Contribution margin ratio for ‘B’ = $ 36800 / 92000 = 40%
>Increase in contribution margin = $ 31700 additional sale x 40%= $ 12680
>Increase in fixed cost = $ 4800
>Decrease in contribution margin of Product A after elimination = $ 42750
>Decrease of avoidable fixed cost = $ 30934

Effect on Profit = Increase in contribution margin of ‘B’ – Decrease in contribution of ‘A’ – Increase in fixed cost + Decrease in avoidable fixed cost
= $ 12680 – 42750 – 4800 + 30934
= $ - 3936

· Correct Answer = Option ‘C’ $ - 3,936