Question

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

			Product A	Product B
Revenue			$91,000	$85,000
Total variable costs			50,960	45,050
Total contribution margin			$40,040	$39,950
Total fixed costs
Avoidable			15,406	28,901
Unavoidable			12,104	25,629
Profit			$12,530	$-14,580

If X Company drops Product B because it shows a loss and is able to use the vacant space to increase sales of Product A by $28,100, with $5,000 of additional fixed costs, what will be the effect on firm profits?

A: $-2,886

B: $-3,261

C: $-3,685

D: $-4,164

E: $-4,706

F: $-5,317

Answer 1

Initial Profit = $12,530 + ($-14,580)

= -$2,050

If X Company drops Product B

Contribution margin ratio of product A = (Contribution margin / Sales)

= ($40,040 / $91,000)

= 44%

Sales of product A increases by $28,100

New sales level = $91,000 + $28,100

= $119,100

Contribution margin = $119,100 * 44%

= $52,404

Total fixed costs of Product A = $15,406 + $12,104 + $5,000(additional fixed costs)

= $32,510

Profit of product A = Contribution margin - total fixed costs

= $52,404 - $32,510

= $19,894

Loss of Product B which is unavoidable = $-25,629

Total profit (loss) of the company = $19,894 + (-$25,629)

= $-5,735

Increase of net loss = $-5,735 - ($-2,050)

= $-3,685