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

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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 is the decision rule for selling a product as is or processing it further?

Explain why a segment with an operating loss can cause the company to have a decrease in total operating income if the segment is dropped.

Newtown Sunglasses sell for about \(154 per pair. Suppose that the company incurs the following average costs per pair:

Direct materials \)39

Direct labor 15

Variable manufacturing overhead 6

Variable selling expenses 3

Fixed manufacturing overhead 20*

Total cost \(83

* \)2,050,000 Total fixed manufacturing overhead / 102,500 Pairs of sunglasses

Newtown has enough idle capacity to accept a one-time-only special order from Water Shades for 17,000 pairs of sunglasses at \(80 per pair. Newtown will not incur any variable selling expenses for the order.

Requirements

1. How would accepting the order affect Newtownโ€™s operating income? In addition to the special orderโ€™s effect on profits, what other (longer-term qualitative) factors should Newtownโ€™s managers consider in deciding whether to accept the order?

2. Newtownโ€™s marketing manager, Peter Kyler, argues against accepting the special order because the offer price of \)80 is less than Newtownโ€™s $83 cost to make the sunglasses. Kyler asks you, as one of Newtownโ€™s staff accountants, to explain whether his analysis is correct. What would you say?

Dan Jacobs, production manager for GreenLife, invested in computer-controlled production machinery last year. He purchased the machinery from Superior Design at a cost of \(3,000,000. A representative from Superior Design has recently contacted Dan because the company has designed an even more efficient piece of machinery. The new design would double the production output of the year-old machinery but would cost GreenLife another \)4,500,000. Jacobs is afraid to bring this new equipment to the company presidentโ€™s attention because he convinced the president to invest $3,000,000 in the machinery last year.

Explain what is relevant and irrelevant to Jacobsโ€™s dilemma. What should he do?

What is the most common constraint faced by merchandisers?

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