Question

Weston Corporation is considering whether to eliminate one of its departments. The department has had a net loss for several years, and Weston's CEO is convinced that eliminating the department will improve Weston's bottom line. The department's contribution margin is $70,000 per year. Weston charges the department with $91,000 of fixed expenses each year, $56,000 of which will be eliminated if the department is eliminated. What would be the result of eliminating this department?

A :
Overall net operating income would decrease by $14,000.
B :
Overall net operating income would increase by $35,000.
C :
Overall net operating income would decrease by $70,000.
D :
Overall net operating income would increase by $21,000.

Answer 1

Eliminating the department would result in saving $56,000 in fixed expenses, but would also mean losing the $70,000 contribution margin, leading to a net decrease in overall operating income by $14,000.

Step-by-step explanation:

The decision to eliminate a department based on its financial performance involves analyzing the department's contribution margin and fixed expenses. In this scenario, Weston Corporation's department has a contribution margin of $70,000, indicating the excess of revenues over variable costs that contributes to covering fixed expenses. The department is charged with $91,000 of fixed expenses, out of which $56,000 will cease if the department is closed.

To determine the financial impact of eliminating the department, we should calculate the net change in operating income. If the department is eliminated, Weston Corporation will save $56,000 in fixed expenses but will also lose the $70,000 contribution margin. Thus, the net operating income would decrease by the difference, which is $14,000 ($70,000 - $56,000).

Consequently, the result of eliminating this department would be option A: Overall net operating income would decrease by $14,000.