Question

A study has been conducted to determine if Product A should be dropped. Sales of the product total $400,000 per year; variable expenses total $270,000 per year. Fixed expenses charged to the product total $160,000 per year. The company estimates that $70,000 of these fixed expenses are not avoidable even if the product is dropped. If Product A is dropped, the company's overall net operating income would:

A. decrease by $40,000 per yearB. increase by $40,000 per yearC. decrease by $30,000 per yearD. increase by $30,000 per year

Answer 1

Option (A) is correct.

Step-by-step explanation:

Contribution Margin:

= Total sales of the product - variable expenses

= $400,000 - $270,000

= $130,000

Avoidable fixed cost = Total fixed cost - Unavoidable fixed cost

= $160,000 - $ 70,000

= $90,000

Net Margin :

= Contribution Margin - Avoidable fixed expense

= $130,000 - $90,000

= $40,000

Hence, if product A is dropped, the company's overall net operating income would decrease by $40,000 per year.