Question

The Regal Cycle Company manufactures three types of bicycles a dirt bike, a mountain bike, and a racing bike. Data on sales and expenses for the past quarter follow:

Total Dirt Mountain Bikes Racing Bikes

Sales $ 300,000 $ 90,000 $ 150,000 $ 60,000
Variable manufacturing and selling expenses 120,000 27,000 60,000 33,000
Contribution margin 180,000 63,000 90,000 27,000
Fixed expenses:
Advertising, traceable 30,000 10,000 14,000 6,000
Depreciation of special equipment 23,000 6,000 9,000 8,000
Salaries of product-line managers 35,000 12,000 13,000 10,000
Allocated common fixed expenses* 60,000 18,000 30,000 12,000
Total fixed expenses 148,000 46,000 66,000 36,000
Net operating income (loss) $ 32,000 $ 17,000 $ 24,000 $ (9,000)
*Allocated on the basis of sales dollars.

Management is concerned about the continued losses shown by the racing bikes and wants a recommendation as to whether or not the line should be discontinued. The special equipment used to produce racing bikes has no resale value and does not wear out.

What is the impact on net operating income by discontinuing racing bikes?

Answer 1

Discontinuing the racing bikes would result in a loss of the product's contribution margin and a saving of some of the traceable fixed costs.

So, my response is No, production and sale of the racing bikes should not be discontinued. If the racing bikes were discontinued, so the net operating income for the company as a whole would reduce by $11,000 each quarter (check image attached)

The formula for calculating NOI is: Net Operating Income (NOI) =Total Revenue−Total Operating Expenses

Based on the above, decrease in Net Operating Income is calculated by:

contribution margin loss - fixed cost.

The contribution margin loss amounts to ($27,000), attributable to avoidable fixed costs including traceable advertising expenses of $6,000 and the product line manager's salary of $10,000, totaling $16,000. This results in an overall decrease in net operating income for the company by ($11,000).

Therefore, It's essential to note that the depreciation of the special equipment is considered a sunk cost and doesn't impact the decision. Additionally, common costs, which are allocated, will persist regardless of the discontinuation of racing bikes and are therefore not pertinent to the decision-making process.