Question

Case #4 Penna Company manufactures three product lines. The following operating data have been gathered for the most recent quarter: Caxton Tinta Bozze Total Sales $750,000 $300,000 $450,000 $1,500,000 Variable costs $450,000 $150,000 $300,000 $900,000 Contribution margin 300,000 150,000 150,000 600,000 Fixed costs Rent $37,500 $15,000 $22,500 $75,000 Depreciation $45,000 $18,000 $27,000 $90,000 Utilities $30,000 $7,500 $22,500 $60,000 Supervision $22,500 $7,500 $45,000 $75,000 Maintenance S22,500 $9,000 $13,500 $45,000 Administrative $45,000 $30,000 $75,000 $150,000 Total fixed costs 202,500 87,000 205,500 495,000 Operating income (loss) $97,500 S63,000 -$55,500 $105,000 After reviewing the financial information, the company's president is wondering whether the Bozze product line should be dropped. Going back through the accounting records, the president noted that the Bozze product line has reported losses in each of the past three quarters. To help with this decision, the company's accountant gathered additional information. If the Bozze product line is dropped: Rent and depreciation expenses would be unaffected. Utilities costs would be reduced from $60,000 per quarter to $46,500. The position of Supervisor for the Bozze product line could be eliminated, thereby saving the Supervisor's salary for that product line. Quarterly maintenance costs would be reduced by $10,500. One of the administrative assistants' positions could be eliminated, thereby saving $40,500 per quarter in Administrative expenses. Required (A) Should Penna Company eliminate the Borze product line? By how much will the company's income increase or decrease by dropping the Bozze product line? (B) Penna Company's sales manager thinks that it is very important for the company to retain all three product lines. The sales manager suspects that eliminating the Bozze will reduce the sales of the remaining two product lines by 5% each. Will this information change your recommendation from (A)? Why or why not? Explain. (C) In general, when management at an organization is analyzing whether to keep or drop a product line, what financial and non-financial factors should be considered? .

Answer 1

(A) If company eliminate the Bozze Product Line:

(i) Decrease in Contribution Margin(Bozze product line) (1)     $150,000

  (ii) Decrease in Fixed Cost (2)

Utilities $13,500

Supervision $45,000

Maintenance $10,500

Administrative $40,500 $109,500

Decrease in Company's Income {(1) - (2)} $40,500  

As the elimination leads to decrease in company's income by $40,500 ,Penna Company should not eliminate the Bozze product line.

(B) The sales manager suspects that eliminating the Bozze product line will lead to reduction in sales of remaining two product line by 5% each.

This information will not change the recommendation from (A). This is so because in Part A also we have concluded that the Bozze product line should not be eliminated.

(C) In keeping or dropping a product line, following factors should be considered(Financial and Non-financial):

• Demand of the product in the market.
• Effect on ovarall profitability of the company due to drop out.
• Relavant cost reduction due to drop out in comparison to loss of contribution.
• Dependability of other product lines on the product line we are planning to drop.