Question

Bed & Bath, a retailing company, has two departments—Hardware and Linens. The company’s most recent monthly contribution format income statement follows:

Sales Variable expenses Contribution margin Fixed expenses Net operating income (loss) Department Total Hardware Linens $ 4,000,000 $3,000,000 $1,000,000 1,300,000 900,000 400,000 2,700,000 2,100,000 600,000 2,200,000 1,400,000 800,000 $ 500,000 $ 700,000 $ (200,000)

A study indicates that $340,000 of the fixed expenses being charged to Linens are sunk costs or allocated costs that will continue even if the Linens Department is dropped. In addition, the elimination of the Linens Department will result in a 10% decrease in the sales of the Hardware Department.

Required:

What is the financial advantage (disadvantage) of discontinuing the Linens Department?

Answer 1

Contribution margin for Hardware would be=2,100,000*(1-0.1)

=$1,890,000

Less:Fixed cost for Hardware=(1,400,000)

Net operating income for Hardware=490,000

Less:Unavoidable fixed costs for Linens=(340,000)

Total net operating income=$150,000

Hence financial disadvantage=(500,000-150,000)

=$350,000