Question

Manor company plans to discontinue a department that has a contribution margin of $25,000 and $50,000 in fixed costs. of the fixed costs, $21,000 cannot be eliminated. what would be the effect on the operating income of manor company of discontinuing this department?

Answer 1

Discontinuing the department with a contribution margin of $25,000 and unavoidable fixed costs of $21,000 would lead to a smaller decrease in operating income ($21,000) compared to the current net loss ($25,000). Consequently, operating income would improve by $4,000.

Step-by-step explanation:

The student is asking about the potential financial impact on Manor company's operating income if a certain department is discontinued. Specifically, the department being considered for discontinuation currently contributes a contribution margin of $25,000 but also incurs $50,000 in fixed costs. However, not all of the fixed costs can be eliminated; $21,000 will remain even if the department is shut down.

To analyze the effect on operating income, the following calculation should be performed: If the department is operational, the net effect is the contribution margin ($25,000) minus the total fixed costs ($50,000), which would be a negative impact of -$25,000 to operating income. However, if the department is discontinued, the company will save the contribution margin but still incur the unavoidable fixed costs of $21,000. Thus, the net effect will be a reduction of $21,000 instead of $25,000 to the operating income. Therefore, the company’s operating income would be $4,000 better off by discontinuing the department.