Question

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

			Product A	Product B
Revenue			$93,000	$85,000
Total variable costs			53,940	51,000
Total contribution margin			$39,060	$34,000
Total fixed costs
Avoidable			28,286	18,266
Unavoidable			22,224	12,694
Profit			$-11,450	$3,040

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 $26,000, with $5,000 of additional fixed costs, what will be the effect on firm profits?

Answer 1

· Calculation of effect on profits:
>Contribution margin ratio for ‘B’ = $ 34000 / 85000 = 40%
>Increase in contribution margin = $ 26000 additional sale x 40%= $ 10400
>Increase in fixed cost = $ 5000
>Decrease in contribution margin of Product A after elimination = $ 39060
>Decrease of avoidable fixed cost = $ 28286

Effect on Profit = Increase in contribution margin of ‘B’ – Decrease in contribution of ‘A’ – Increase in fixed cost + Decrease in avoidable fixed cost
= $ 10400 – 39060 – 5000 + 28286
= $ - 5374

· Correct Answer = $ - 5374