Question

Structuring a Keep-or-Drop Product Line Problem

Shown below is a segmented income statement for Orzo Company's three laminated flooring product lines:

	Strip		Plank		Parquet		Total
Sales revenue	$400,000		$200,000		$300,000		$900,000
Less: Variable expenses	225,000		120,000		250,000		595,000
Contribution margin	$175,000		$ 80,000		$ 50,000		$305,000
Less direct fixed expenses:
Machine rent	(5,000)		(20,000)		(50,000)		(75,000)
Supervision	(15,000)		(10,000)		(20,000)		(45,000)
Depreciation	(35,000)		(10,000)		(25,000)		(70,000)
Segment margin	$120,000		$ 40,000		$ (45,000)		$115,000

Orzo's management is deciding whether to keep or drop the parquet product line. Orzo's parquet flooring product line has a contribution margin of $50,000 (sales of $300,000 less total variable costs of $250,000). All variable costs are relevant. Relevant fixed costs associated with this line include $30,000 in machine rent and $4,700 in supervision salaries.

Required:

1. List the alternatives being considered with respect to the parquet flooring line.

2. List the relevant benefits and costs for keeping the parquet flooring line?

3. Which alternative is more cost effective and by how much?
  by $

Answer 1

1.
Keep the Parquet line
Drop the Parquet line

2.

	Keep	Drop
Relevant benefits
Sales	$        300,000	$                  -
Relevant Costs
Variable costs	$        250,000	$                  -
Fixed Cost	$          95,000	$         60,300
Total Relevant Costs	$        345,000	$         60,300
Net benefit	$        (45,000)	$       (60,300)

3.
Keeping the parquet flooring line is more cost effective by $15300

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