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Chapter 25: Q25-16RQ (page 1373)

What questions should managers answer when considering dropping a product or segment?

Short Answer

Expert verified

Answer

When considering dropping a product or segment, managers must answer some major questions, such as the impact of dropping theoverall contributionand avoidable fixed costs factors associated with such segment or product.

Step by step solution

01

Step-by-Step SolutionStep 1: Meaning of Contribution

Contribution refers to the profit left in the hands of a business entity after recovering all its variable costs from the sales revenue. It is computed by taking the difference betweenselling price per unit and variable cost per unit.

02

Factors to be answered when dropping a product or segment

Manager must answer the following questions when dropping a product or a segment:

  • First of all, managers must answer whether dropping a segment or product will result in an improved contribution.

It is the responsibility of managers to consider the factors associated with the contribution margin before dropping aproduct or segment. If the product has a negative contribution, it shows that the same will not be able to cover its variable costs, which will result in decreased overall contribution and vice-versa.

  • Managers should verify whether such a product or segment has anyavoidable fixed cost.

If there is any avoidable fixed cost, then dropping a segment or product generally improves the company'snet income. This is one reason why managers must consider avoidable fixed costs before dropping a product or segment.

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Most popular questions from this chapter

What questions should managers answer when setting regular prices?

Suppose Roasted Pepper restaurant is considering whether to (1) bake bread for its restaurant in-house or (2) buy the bread from a local bakery. The chef estimates that variable costs of making each loaf include \(0.52 of ingredients, \)0.27 of variable overhead (electricity to run the oven), and \(0.79 of direct labor for kneading and forming the loaves. Allocating fixed overhead (depreciation on the kitchen equipment and building) based on direct labor, Roasted Pepper assigns \)0.96 of fixed overhead per loaf. None of the fixed costs are avoidable. The local bakery would charge $1.78 per loaf.

Requirements

1. What is the full product unit cost of making the bread in-house?

2. Should Roasted Pepper bake the bread in-house or buy from the local bakery? Why?

3. In addition to the financial analysis, what else should Roasted Pepper consider when making this decision?

StoreAll produces plastic storage bins for household storage needs. The company makes two sizes of bins: large (50 gallon) and regular (35 gallon). Demand for the products is so high that StoreAll can sell as many of each size as it can produce. The company uses the same machinery to produce both sizes. The machinery can be run for only 3,300 hours per period. StoreAll can produce 10 large bins every hour, whereas it can produce 17 regular bins in the same amount of time. Fixed costs amount to \(115,000 per period. Sales prices and variable costs are as follows:

Regular Large

Sales price per unit \)8.00 $10.40

Variable cost per unit 3.50 4.40

Requirements

1. Which product should StoreAll emphasize? Why?

2. To maximize profits, how many of each size bin should StoreAll produce?

3. Given this product mix, what will the company鈥檚 operating income be?

What are the two keys in short-term decision making?

What are joint costs? How do they affect the sell or process further decision?
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