Question

path, rerailing comemaenys rments, Hardware and Liners. The company's most recent imonthly n format income statement follows Total Hardware $4,200,000 3,000,000 1,200,000 Linens Sales Variable expenses 2,000,000 1500000 500,000 Contribution Margin Fixed Expenses Net operating income (loss) 2,200,000 1,500,000 700,000 2.200,000 900,000 200,000 (200,000) A study indicates that $100,000 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. If the Linens Department is dropped, what will be the effect on the net operating income of the company as a whole? a. Decrease by $400,000 b. Decrease by $300,000 c. Decrease by $150,000 d. Decrease by $200,000 e. Decrease by $250,000

Answer 1

Answer- If the Linen department is dropped, the net operating income of the company as a whole will decrease by $200000.

Explanation-

Contribution margin lost if the Linen Department is dropped:
Particulars	Amount
	$
Lost from the Linen Department	700000
Add- Lost from the Hardware Department (20% *$1500000)	300000
Total lost contribution margin	1000000
Less- Fixed costs that can be avoided ($900000 – $100000)	800000
Decrease in profits for the company as a whole	200000

The Linen department should not be discontinued otherwise company will loose a profit of $200000. The unavoidable fixed costs will continue to occur whether department is discontinued or not hence not relevant for decision making and should be ignored.