Question

Betty DeRose, Inc. sells three products. Income statements for the three
products for the most recent year appear below:

                                   Product #1     Product #2     Product #3
Sales revenue  ................     $140,000       $120,000       $200,000
Costs:
  Variable production costs ...       91,000         48,000        140,000
  Advertising .................       15,000         12,000         10,000
  Rent ........................       14,000         14,000         14,000
  Supervisor's salary .........       20,000         20,000         20,000
  Sales commissions ...........        7,000          6,000         10,000
Net income/loss ...............       <7,000>        20,000          6,000

The rent is allocated to the three products equally and sales commissions
are paid at a rate of 5% of sales.

The company is considering eliminating Product #1. If Product #1 is dropped,
the contribution margin of Product #2 is expected to increase by 15%. 

Calculate the amount the company's net income will increase by if Product #1
is dropped.

Answer 1

Preparation of Income statement is as follows:-

When Product 1 is dropped then Product 2 contribution margin is $66,000 * 115% = $75,900

| Total 460,000.00 Product 1 140,000.00 Product 2 120,000.00 Product 3 200,000.00 $ $ $ $ $ $ $ $ 279,000.00 $ 23,000.00 $ 302,000.00 $ 158,000.00 $ 91,000.00 $ 7,000.00 $ 98,000.00 $ 42,000.00 $ 48,000.00 $ 6,000.00 $ 54,000.00 $ 66,000.00 $ 140,000.00 10,000.00 150,000.00 50,000.00 Sales revenue Less: Variable costs Variable production costs Sales commissions Total Variable costs Contribution margin Less: Identifiable fixed costs Advertising Supervisor's salary Total Identifiable costs Segment margin Less: Common fixed costs Rent Net Income /(loss) $ $ 37,000.00 $ 60,000.00 $ 97,000.00 $ 61,000.00 $ 15,000.00 20,000.00 35,000.00 7,000.00 $ $ $ $ 12,000.00 $ 20,000.00 $ 32,000.00 $ 34,000.00 $ 10,000.00 20,000.00 30,000.00 20,000.00 $ $ $ $ 42,000.00 19,000.00 If Product 1 is dropped Total 125,900.00 $ Product 2 75,900.00 $ Product 3 50,000.00 $ Contribution margin Less: Identifiable fixed costs Advertising Supervisor's salary Total Identifiable costs Segment margin Less: Common fixed costs Rent Net Income / (loss) $ $ $ $ 22,000.00 $ 40,000.00 $ 62,000.00 $ 63,900.00 $ 12,000.00 $ 20,000.00 $ 32,000.00 $ 43,900.00 $ 10,000.00 20,000.00 30,000.00 20,000.00 $ $ 42,000.00 21,900.00

If product 1 is dropped the the Net Income will rise by $2,900 i.e. ($21,900 - $19,000)