Question:
The following information relates to next year's projected operating results of the Children's Division of Grunge Clothing Corporation:
Contribution margin.... 200,000
Fixed Expense.... 500,000
net operating loss..... (300,000)
If Children's Division is dropped, half of the fixed costs above can be eliminated. What will be the effect on Grunge's profit next year if Children's Division is dropped instead of being kept?
A) 50,000 increase
B) 250,000 increase
C)250,000 decrease
D) 550,000 increase
Answer:
Option A is correct
Increase in profit = $50,000
Explanation:
To determine whether or not it will be profitable to drop a loss making division, we compare the savings in fixed cost to the lost contribution from the division.
It is noteworthy that only the fixed cost attributed to division can only be saved should the division be shut down.
The analysis is done as follows:
$
Lost contribution (200,000 )
Savings in fixed cost (1/2× 500,000) 250,000
Net savings 50,000
Increase in profit = $50,000
