Question

lo ta 12/ 1z 5, 25,650 73 050 l,15 2,500

I need someone to please explain/show me how to redistribute the common fixed cost of Azul the correct way. I'm not necessarily looking for an answer.. I just need the steps involved in this part and maybe the following. Thank you.

Answer 1

In a decision as to whether a product line should be discontinued or not, the decision rule is :

If the Contribution Margin Lost < Avoidable Costs : Drop the product line

If the Contrbution Margin Lost > Avoidable Costs : Do not drop the product line.

Avoidable costs include all variable costs and all direct fixed costs.

So we start with a differential analysis first to ascertain whether there would be an increase or decrease in net operating income if the Azul Model were to be discontinued.

1. Differential Analysis:

	Do not eliminate Azul	Eliminate Azul	Increase ( decrease) in Net Operating Income
	$	$	$
Sales Revenue	150,000	135,000	(15,000)
Variable Costs	91,000	73,050	17,950
Contribution Margin	59,000	61,950	2,950
Less Direct Fixed Costs	6,400	4,400	2,000
Segment Margin	52,600	57,550	4,950
Common Fixed Costs	44,600	44,600	0
Total	8,000	12,950	4,950

If the Azul model is eliminated, net operating income will increase by $ 4,950.

	Indigo	Verde	Total
Sales	66,000	69,000	135,000
Variable Costs	37,400	35,650	73,050
Contribution Margin	28,600	33,350	61,950
Less: Direct Fixed Costs	1,900	2,500	4,400
Segment Margin	26,700	30,850	57,550
Common Fixed Costs	21,804	22,796	44,600
Net Operating Income	4,896	8,054	12,950

2. Yes, Mohave should drop the Azul Model.

3. Yes, I would still recommend Mohave to change, as the increase in net operating income of $ 4,950 exceeds the direct fixed cost of $ 2,000 attributable to the Azul model. Net operating income would still increase by $ 2,950 on the elimination of the Azul Model.