Question

Mohave Corp. is considering eliminating a product from its Sand Trap line of beach umbrellas. This collection is aimed at people who spend time on the beach or have an outdoor patio near the beach. Two products, the Indigo and Verde umbrellas, have impressive sales. However, sales for the Azul model have been dismal.       

Mohave’s information related to the Sand Trap line is shown below.       
 

Segmented Income Statement for Mohave’s
Sand Trap Beach Umbrella Products
	Indigo			Verde			Azul				Total
Sales revenue	$	60,000		$	60,000		$	30,000			$	150,000
Variable costs		34,000			31,000			26,000				91,000
Contribution margin	$	26,000		$	29,000		$	4,000			$	59,000
Less: Direct fixed costs		1,900			2,500			2,000				6,400
Segment margin	$	24,100		$	26,500		$	2,000			$	52,600
Common fixed costs*		17,840			17,840			8,920				44,600
Net operating income (loss)	$	6,260		$	8,660		$	(6,920	)		$	8,000

*Allocated based on total sales revenue

 

Mohave has determined that eliminating the Azul model would cause sales of the Indigo and Verde models to increase by 10 percent and 15 percent, respectively. Variable costs for these two models would increase proportionately. Although the direct fixed costs could be eliminated, the common fixed costs are unavoidable. The common fixed costs would be redistributed to the remaining two products.

Required:
1-a. Complete the table given below, assuming Mohave Corp. drops the Azul line.
1-b. Will Mohave’s net operating income increase or decrease if the Azul model is eliminated? By how much?
2. Should Mohave drop the Azul model?
3-a. Complete the table given below assuming that Mohave had no direct fixed overhead in its production information and the entire $51,000 of fixed cost was common fixed cost.
3-b. Should Mohave drop the Azul model?
3-c. What is the increase or decrease in the net operating income of Mohave?

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Answer 1