Question

Barbour Corporation, located in Buffalo, New York, is a retailer of high-tech products and is known for its excellent quality and innovation. Recently, the firm conducted a relevant cost analysis of one of its product lines that has only two products, T-1 and T-2. The sales for T-2 are decreasing and the purchase costs are increasing. The firm might drop T-2 and sell only T-1. Barbour allocates fixed costs to products on the basis of sales revenue. When the president of Barbour saw the income statements (see below), he agreed that T-2 should be dropped. If T-2 is dropped, sales of T-1 are expected to increase by 10% next year, but the firm's cost structure will remain the same. T-1 $250,000 T-2 $300,000 80,000 32,500 $137,500 150,000 60,000 $ 90,000 Sales Variable costs: Cost of goods sold Selling & administrative Contribution margin Fixed expenses: Fixed corporate costs Fixed selling and administrative Total fixed expenses Operating income 70,000 22,000 $ 92,000 $ 45,500 85,000 31,000 $116,000 $(26,000) Required: 1. Find the expected change in annual operating income by dropping T-2 and selling only T-1. 2. By what percentage would sales from T-1 have to increase in order to make up the financial loss from dropping T-2? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).) 3. What is the required percentage increase in sales from T-1 to compensate for lost margin from T-2, if total fixed costs can be reduced by $54,500? (Enter your answer as a percentage rounded to 2 decimal places (i.e. 0.1234 should be entered as 12.34).)

Answer 1

requirement 1.
1. income statement when t2 is dropped and only t1 is sold: Amount ($) 275000 Basis 250000+10% 88000 35750 80000+10% 32500+10% 151250 Sales (-) variable costs: 1. cost of goods sold 2. sellingand administration : Contribution margin fixed costs: 1.fixed corporate cost 2. selling and administation cost Total fixed costs Operating income/(loss) 155000 53000 75000+85000 22000+31000 208000 (56750)

Note: 1. When sales of t1 increases by 10% in the next year, it means that units sold increases. As a result total variable cost also increases.

2. when t2 is dropped in the next year, the variable costs relating the t2 will no be incurred in the next year. But in the question it is mentior ed that cost structure remains sarne and also said. that the fixed costs will be allocated on sales basis. that means the total fixed cots remains same in the next year and the total fixe cost will be allocated to t1

requirement 2.
2. The financial loss by dropping t2 is $90000, that is its contribution margin. Therefore, The increase in sales to cover the loss of $90000 = total contribution margin/contribution margin ratio of t1. Where, CM ratio of t1 = contribution margin / sales = $137500/$250000 = 0.55 or 55% Therefore,

W increase in sales to cover the loss of $90000 = $90000/55% = $163637 % increase in sales to cover the loss =( $163637/$250000*100) = 65.45%
requirement 3.

3. When fixed cots reduces by $54500 then the contribution margin loss from dropping t2 = $35500 ($90000-$54500). Therefore, Increases in sales required to cover margin loss of $35500 = $35500/55% = $64546 % Increases in sales required to cover margin loss = ($64545/$250000)*100 = 25.82%