Question

State Road Fabricators Inc. is considering eliminating Model A02777 because of losses over the past quarter. The past three months of information for Model A02777 are summarized below: Sales (1,100 units) $470,000 Manufacturing costs: Direct materials 160,000 Direct labor ($15 per hour) 80,000 Overhead 150,000 Operating loss ($80,000) Overhead costs are 75% variable and the remaining 25% is depreciation of special equipment for model A02777 that has no resale value. If Model A02777 is dropped from the product line, operating income will ________.

Answer 1

Answer :

The operation will decrease by $117,500

Explanation :

As per the data given in the question,

                          State road Fabricators Inc.

                                  Income Statement

Particulars                          Amount

Sales                                $470,000

Less: Manufacturing cost

Direct materials                 $160,000

Direct Labor                      $80,000

Overhead Variable part    $112,500      ($150,000 × 75%)

Operating income             $117,500

Working notes  

1) In overhead cost only variable part ($112,500) will be considered for decision

hence, variable cost of overhead is relevant cost.

2) Fixed part of overhead cost ($150,000*25% = $37,500) is unavoidable s it is a sunk cost.

3) Company should not drop the product line.