Question

Company manufactures two products. Both products have the same sales​ price, and the volume of sales is equivalent.​ However, due to the difference in production​ processes, Product A has higher variable costs and Product B has higher fixed costs. Management is considering dropping Product B because that product line has an operating loss.
Total Product A Product B
Sales Revenue $140,000 $70,000 $70,000
Variable Costs 124,250 63,500 60,750
Contribution Margin 15,750 6,500 9,250
Fixed Costs 30,000 3,000 27,000
Operating Income/(Loss) $(14,250) $3,500 $ (17,750)


Required:
a. If fixed costs cannot be avoided, should Richardson drop Product B? Why or why not?
b. If 50% of Product B's fixed costs are avoidable, should Richardson drop Product B? Why or why not?

Answer 1

Answer:

a. No - Because Richardson will be worse off than what he was before.

b. Yes - Because Richardson will be better off than what he was before.

Explanation:

a. Analysis of Operating Income is Richardson drop Product B

Sales Revenue                  $70,000

Less Variable Costs        ($63,500)

Contribution                        $6,500

Fixed Costs                      ($30,000)

Total Operating Income  ($23,500)

Dropping Product B will result in Total Operating Loss of $23,500. This means Richardson will be worse off than what he was before. He should not drop the product in this case.

b. Analysis of Operating Income is Richardson drop Product B

Sales Revenue                  $70,000

Less Variable Costs        ($63,500)

Contribution                        $6,500

Fixed Costs                      ($15,000)

Total Operating Income   ($8,500)

Dropping Product B will result in Total Operating Loss of $8,500. This means Richardson will be better off than what he was before. He should  drop the product in this case.