Question

Product R2 $30,000 18,000 12,000 Product R4 Product R2D2 $45,000 $12,000 24,000 7,500 21,000 4,500 Sales Variable costs Contribution margin Fixed costs: Avoidable Unavoidable Operating income 3,000 4,500 3.0001 $4.500 9,000 4,500 $7.500 2.7001 $(1.200 Donnelly Company is thinking of dropping Product R2D2 because it is reporting a loss. Required: 1) What will be the resulting operating income assuming Donnelly drops Product R2D2 and does not replace it?s 2) As an alternative what will be the resulting operating income assuming Product R2D2 is discontinued and the space formerly used to produce the product is rented for $6,000 per year?

Answer 1

1.

Calculate the resulting operating income assuming Product R2D2 is dropped as follows:

Sales	75000	(30000+45000)
Variable costs	42000	(18000+24000)
Contribution margin	33000	(75000-42000)
Fixed costs:
Avoidable	13500	(4500+9000)
Unavoidable	10200	(3000+4500+2700)
Operating income	9300	(33000-13500-10200)

The resulting operating income will be $9,300.

There will be a decrease in operating income of $1,500 if R2D2 is dropped.

2.

If the space formerly used to produce the product is rented for $6,000 per year:

Resulting operating income = $9,300 + $6,000 = $15,300

There will be an increase of $4,500 in the resulting operating income.