Question

The following information relates to next year's projected operating results of the Children's Division of Grunge Clothing Corporation:
Contribution margin.... 200,000
Fixed Expense.... 500,000
Net operating loss..... (300,000)

If Children's Division is dropped, half of the fixed costs above can be eliminated. What will be the effect on Grunge's profit next year if Children's Division is dropped instead of being kept?

a. 50,000 increase
b. 250,000 increase
c. 250,000 decrease
d. 550,000 increase

Answer 1

Answer:

a. 50,000 increase

Explanation:

the company will save money by discontinuing this division since currently it is losing $300,000, but if it discontinues this division, it will only lose $250,000 which means that operating income will increase by $50,000

differential analysis:

                                      option 1                     option 2                 differential

                                      continue operating  discontinue oper.  amount

contribution margin      $200,000                 $0                          ($200,000)

fixed expenses            ($500,000)                ($250,000)             $250,000

net change                   ($300,000)                ($250,000)              $50,000