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		$	3,130,000		$	1,190,000
Variable expenses		1,262,000			854,000			408,000
Contribution margin		3,058,000			2,276,000			782,000
Fixed expenses		2,240,000			1,430,000			810,000
Net operating income (loss)	$	818,000		$	846,000		$	(28,000	)

A study indicates that $373,000 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 14% 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

Contribution margin for Hardware would be=$2,276,000*(1-0.14)=1,957,360

Less:Fixed expenses for Hardware=(1,430,000)

Net operating income for Hardware=$527360

Less:Unavoidable fixed cost for Linens=(373000)

Total Net operating income would be=$154360

Hence financial disadvantage=818,000-154360

=$663640.