Question

Ocean Company manufactures and sells three different products: Jay, Kay and Oh. Projected income statements by product line for the year are presented below:

Jay Kay Oh Total

Unit Sales 10,000 500,000 125,000 635,000

Sales Revenue $925,000 $1,000,000 $575,000 $2,500,000

Variable costs(mftg) 285,000 350,000 150,000 785,000

Fixed costs(mftg) 304,200 289,000 166,800 760,000

Gross Margin 335,800 361,000 258,200 955,000

Variable costs(non-mftg) 270,000 200,000 80,000 550,000

Fixed costs(non-mftg) 125,800 136,000 78,200 340,000

Operating profit $(60,000) $25,000 $100,000 $65,000

  

Fixed nonmanufacturing costs are allocated to products in proportion to revenues. The fixed manufacturing costs are allocated to products by various allocation bases, such as square feet for factory rent, machine-hours for repairs, and so forth.

Variable non-manufacturing costs are 100% sales related.

Ocean management is concerned about the loss on product Jay and is considering an alternative course of corrective action.

Alternative: Ocean would discontinue the manufacture of product Jay. As a result of this change, the selling prices of products Kay and Oh would remain constant. Management expects that product Oh production and sales revenue would increase by 50%. The machinery devoted to product Jay could be sold at scrap value that equals its removal costs (i.e., no gain or loss). Removal of this machinery would reduce fixed costs by $30,000 per year. The remaining fixed costs allocated to product Jay can be rented to an outside organization for $157,500 per year.

Required: (Read these instructions and make sure to complete the requirements.) Compute the effect of this alternative. This must be shown from a "relevant cost" perspective. If you compute your answer using all costs, label each item as relevant/irrelevant. If you feel the need to make an assumption, then do so.  

Answer 1

Contribution Margin Lost from Product Jay	$     -3,70,000	=-(925000-285000-270000)
Increase in Contribution Margin from Product Oh	$      1,72,500	=(575000-150000-80000)*50%
Savings of Fixed Costs	$         30,000
Rent from Outside Organization	$      1,57,500
Net Benefit (Loss)	$        -10,000