Question

Bed & Bath, a retailing company, has two departments, Hardware and Linens. The company’s most recent monthly contribution format income statement follows:

				Department
	Total			Hardware			Linens
Sales	$	4,320,000		$	3,160,000		$	1,160,000
Variable expenses		1,265,000			858,000			407,000
Contribution margin		3,055,000			2,302,000			753,000
Fixed expenses		2,180,000			1,320,000			860,000
Net operating income (loss)	$	875,000		$	982,000		$	(107,000	)

A study indicates that $377,000 of the fixed expenses being charged to Linens are sunk costs or allocated costs that will continue even if the Linens Department is dropped. In addition, the elimination of the Linens Department will result in a 20% decrease in the sales of the Hardware Department.

Required:

If the Linens Department is dropped, what will be the effect on the net operating income of the company as a whole?

Answer 1

Disadvantage $730,400
Contribution margin lost if the Linen Department is dropped:
Lost from the Linen Department	$753,000
Lost from the Hardware Department (20% × $2,302,000)	$460,400
Total lost contribution margin	$1,213,400
Less fixed costs that can be avoided ($860,000 – $377,000)	$483,000
Decrease in profits for the company as a whole	$730,400