Keep Or Drop A Product.. Accounting Problem?

Hamburg, Inc. is considering dropping one product line due to continuing losses. If the product line is discontinued, then Hamburg could avoid $111,300 per year in fixed costs. Revenue and cost data for the product line for the past year follow:
Sales (20,000 units) $300,000
Variable costs 180,000
Contribution margin 120,000
Fixed costs 140,000
a. From a purely economic perspective, Hamburg would be indifferent between discontinuing or continuing the product line at 18,550 units of annual sales. Why?
b. Suppose that if the product line were dropped, the production and sale of other products would increase so as to generate a $15,000 increase in the contribution margin received from the other products. If all other conditions are the same (and the fixed cost reduction of $111,300 is still applicable), what is the change in annual operating income from dropping the product line?

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One Response to “Keep Or Drop A Product.. Accounting Problem?”

  1. buz says:

    a) at 18,550 units, the product line contribution margin covers 111,300 of fixed costs. The remaining fixed costs of 28,700 would remain whether the company produces the product or not
    b)
    loss of contribution margin from discontinuing product line 20,000 x 6 = (120,000)
    additional contribution margin from other products 15,000
    reduction in fixed costs 111,300
    net change in operating income from discontinuing product line + 6,300

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