Question

Agnew Manufacturing produces and sells three models of a single product, Standard, Superior, and DeLuxe, in a local market and in a regional market. At the end of the first quarter of the current year, the following income statement (in thousands of dollars) has been prepared:

	Total			Local			Regional
Sales revenue	$	15,450		$	11,910		$	3,540
Cost of goods sold		12,140			9,310			2,830
Gross margin	$	3,310		$	2,600		$	710
Marketing costs		1,240			710			530
Administrative costs		612			470			142
Total marketing and administrative	$	1,852		$	1,180		$	672
Operating profits	$	1,458		$	1,420		$	38

Management has expressed special concern with the regional market because of the extremely poor return on sales. This market was entered a year ago because of excess capacity. It was originally believed that the return on sales would improve with time, but after a year, no noticeable improvement can be seen from the results as reported in the preceding quarterly statement.

In attempting to decide whether to eliminate the regional market, the following information has been gathered:

	Products
	Standard			Superior			DeLuxe
Sales revenue	$	5,950		$	4,750		$	4,750
Variable manufacturing costs as a percentage of sales revenue		60	%		70	%		60	%
Variable marketing costs as a percentage of sales revenue		4			2			2

Product Sales by Markets	Local			Regional
Standard	$	4,770		$	1,180
Superior		3,570			1,180
DeLuxe		3,570			1,180

All administrative costs and fixed manufacturing costs would not be affected by eliminating the regional market. Marketing costs that are not listed above as variable are fixed for the period and separable by market. Fixed marketing costs assigned to the regional market would be saved if that market were eliminated.

Required:

a. Assuming there are no alternative uses for Agnew's present capacity, would you recommend dropping the regional market?

	Yes
	No

b. Prepare the quarterly income statement showing contribution margins by products. Do not allocate fixed costs to products. (Enter your answer in thousands of dollars.)

c. It is believed that a new model can be ready for sale next year if Agnew decides to go ahead with continued research. The new product would replace DeLuxe and can be produced by simply converting equipment presently used in producing the DeLuxe model. This conversion will increase fixed costs by $118,000 per quarter. What must be the minimum contribution margin per quarter for the new model to make the changeover financially feasible? (Enter your answer in thousands of dollars.)

Answer 1

No, since it is giving positive contribution to profits
	Standard	Superior	Deluxe	Total
Sales Revenue	5,950	4,750	4,750	15,450
Less: Variable costs
Variable manufacturing costs	3,570	3,325	2,850	9,745
Variable marketing costs	238	95	95	428
Total variable costs	3,808	3,420	2,945	10,173
Contirbution Margin	2,142	1,330	1,805	5,277
c. Minimum contribbution Margin = Current Contribution Margin from Deluxe + Increase in fixed costs
=$1805+118 = $1,923