Question

Bed & Bath, a retailing company, has two departments: Hardware and Linens.

The company's most recent monthly contribution format income statement follows:

Total Hardware Linens
Sales $4,180,000 $3,100,000 $1,080,000
Variable expenses 1,308,000 891,000 417,000
Contribution margin 2,872,000 2,209,000 663,000
Fixed expenses 2,120,000 1,320,000 800,000
Net operating income (loss) $752,000 $889,000 $(137,000)

A study indicates that $375,000 of the fixed expenses being charged to Linens are sunk costs or allocated costs that will continue even if the Linens Department is dropped. In addition, the elimination of the Linens Department will result in a 12% decrease in the sales of the Hardware Department.

Required:
If the Linens Department is dropped, what will be the effect on the net operating income of the company as a whole?

Answer 1

Net Operating Income will decrease by $503,080.

Step-by-step explanation:

Sales of Hardware after 12% decrease will be $3,100,000 * 88% (100 - 12) = $2,728,000

Variable Expenses of Hardware after 12% decrease 891,000 * 88% (100 - 12) = $784,080

Net Operating Income of Hardware after 12% decrease = $623,920

The sunk cost for Linens fixed cost will be deducted to find the total of net operating income

$623,920 - $375,000 = $248,920

$248,920 is the net operating income after dropping Linens

The increase or decrease is calculated by finding the difference between current and old total net operating income

$248,920 - $752,000 = $503,080