Question

Question 3 Bubbles Corporation manufactures and sells a number of products, including a product called JMS7. Results for last year for the manufacture and sale of JMS7s are as follows:

Sales				$	960,000
Less expenses:
Variable production costs	$	464,000
Sales commissions		144,000
Salary of product manager		100,000
Fixed product advertising		160,000
Fixed manufacturing overhead		132,000			1,000,000
Net operating loss				$	(40,000	)

Bubbles is trying to decide whether to discontinue the manufacture and sale of JMS7s. All expenses other than fixed manufacturing overhead are avoidable if the product is dropped. None of the fixed manufacturing overhead is avoidable.

1. Assume that dropping Product JMS7 will have no effect on other products. What is the annual financial advantage (disadvantage) for the company of eliminating this product?
2. Return to the original information. Now instead, assume that dropping Product JMS7 would result in a $90,000 increase in the contribution margin of other products. What is the annual financial advantage (disadvantage) for the company of eliminating this product under this scenario?

Answer 1

a.

On eliminating JMS7s, operating loss will be,

Sales revenue		$0
Less expenses
Variable production cost	$0
Sales commission	$0
Salary of production manager	$0
Fixed product advertising	$0
Fixed manufacturing overhead	$132,000	$132,000
Net operating loss		($132,000)

Annual financial disadvantage = - $132,000 – (- $ 40,000) = -$ 132,000 + $ 40,000 = - $ 92,000

b.

Annual financial disadvantage = Net operating loss on eliminating + increase in contribution

= - $ 132,000 + $ 92,000 = -$ 42,000

Bubbles should continue JMS7s.