Question

O'Neil Enterprises produces a line of canned soups for sale at supermarkets across the country. Demand has been 'soft'' recently and the company is operating at 75 percent of capacity. The company is considering dropping one of the soups, beef barley, in hopes of improving profitability. If beef barley is dropped, the revenue associated with it will be lost and the related variable costs saved. The CFO estimates that the fixed costs will also be reduced by 25 percent. The following product line statements are available: Product Sales Variable costs Contribution margin Fixed costs allocated to each product line Operating profit (logs) Broth $34,200 22,500 $11.700 5,700 $ 6,000 Beef Barley $44,300 39,600 $ 4,700 7,000 $12,300) Minestrone $52,700 41,100 $11,600 8,100 $ 3,500 Required: a-1. Complete the following differential cost schedule. Status Quo Alternative: Drop Beef Barley Difference (all lower under the alternative) Revenue Less: Variable costs Contribution margin Less: Fixed costs Operating profit (loss)

Answer 1

O'Neil Enterprises Requirement al Revenue Less:Variable cost Contribution Margin Less:Fixed Cost Operating profit (loss) Status Quo Drop Beef Barley Difference 131200 86900 44300 -103200 -63600 -39600 28000 23300 4700 -20800 -15600 -5200 7200 7700 500 20800 x 75% = 15600 Requirement a2 Based on the financial information, O'Neil should drop the beef barley line, because the loss of its contribution margin is less than the reduction in fixed costs. Requirement b1 Revenue Less:Variable cost Contribution Margin Less:Fixed Cost Operating profit (loss) Status Quo Drop Beef Barley Difference 131200 78210 52990 -103200 -57240 -45960 28000 20970 7030 -20800 -15600 -5200 7200 5370 1830 Revenue: $78,210 = (34200+52700) x 0.9 Variable cost: $(57,240) = ($22500+$41100) x 0.90 Requirement b2 Based on the financial information, O'Neil should not drop the beef barley line, because the loss of its contribution margin is greater than the reduction in fixed costs. This indicates the importance of considering cross-product demands and the danger of relying on product-line income statements alone.