10.6 Decision Making - Keep or Drop Flashcards
When a company decides to divest a segment, the underlying reason for this decision could be any one of the following except
A. The segment is a chronic loser and the company is unwilling to commit the resources to make it profitable.
B. Another company is willing to pay a higher price for the segment than its present value to the current owner.
C. As a result of a change in the company’s long-range strategy, what was once a good fit is no longer a good fit.
D. The realization of economies of scale where average cost declines as volume increases.
D. The realization of economies of scale where average cost declines as volume increases.
Reasons for divestitures include governmental antitrust litigation, refocusing of a firm’s operations, and raising capital for the core business operation. The realization of economies of scale where average cost declines as volume increases is not a reason for a company to decide to divest a segment.
A company sells two products that are manufactured in the same production department on two different machines. The contribution margin per unit of the two products is $120 and $80, respectively. When deciding if the second product should be discontinued, which one of the following pieces of information is needed to make the correct decision?
A. Alternative use of the second product’s space.
B. Depreciation expense of the second product’s machinery.
C. Commissions paid on the second product’s sales.
D. Production department manager’s salary.
A. Alternative use of the second product’s space.
If the second product is discontinued, the current space devoted to its production may be converted into a space for a new product to generate additional profit. However, if no alternative use exists for the space, it may be more beneficial to continue producing the second product. Thus, the alternative use of the second product’s space needs to be known in order to make the correct decision.
Superior Tables is a table manufacturer. The company is considering eliminating the Easy Living product line because of losses over the past year. Results for the year just ended for the Easy Living product line are as follows.
Sales (20,000 units): $ 6,000,000
Variable manufacturing costs: 2,700,000
Fixed manufacturing costs: 2,400,000
Administrative costs: 2,000,000
Operating loss: $(1,100,000)
None of the fixed manufacturing costs can be eliminated, but 25% of the administrative costs are variable and can be eliminated if the product line is eliminated. Based on the information above, should the Easy Living product line be eliminated?
A. Yes, because eliminating the product line would increase the operating income by $1,100,000.
B. No, because eliminating the product line would increase the operating loss by $(2,800,000)
C. No, because eliminating the product line would only save $500,000 of administrative costs still resulting in an overall loss.
D. Yes, because eliminating the product line would increase the operating income by $1,500,000 from the saved administrative costs.
B. No, because eliminating the product line would increase the operating loss by $(2,800,000).
If the Easy Living product line is eliminated, the following items will be eliminated:
* Revenues = $6,000,000
* Variable manufacturing costs = $2,700,000
* Partial administrative costs = $500,000
Only the following components will remain:
* Fixed manufacturing costs = $2,400,000
* Administrative costs = $1,500,000
The result is a net loss of $(3,900,000), which is a $(2,800,000) greater loss than the current net loss of $(1,100,000). Thus, eliminating the Easy Living product line is unfavorable because it results in a higher net loss than continuing to operate the line.
