Now it's your turn. DEF Company makes
two types of wicker baskets: basic baskets and premium baskets.
The company is considering dropping its line of
premium wicker baskets because it shows a loss of $30,000.
Managers of the company consult with their accountant to
understand their costs and are presented with the following information.
The company sells 10,000 premium baskets.
Variable manufacturing costs are $18 per unit.
Variable selling costs are $2 per unit.
Fixed manufacturing overhead 8 per unit.
Fixed selling and administrative costs are 10 per unit.
So, the baskets have a total cost of $38 each.
After much discussion, the managers decide that they expect to
avoid incurring the variable costs if they discontinue the premium line of baskets,
but they do not believe they will be able to cut any of the fixed costs.
Follow the steps in
our decision-making framework and see if you can answer the following questions.
What is the decision to be made?
What are the alternatives?
What information is relevant to making the decision?
And which alternative should the company choose?
Take a few minutes, give it a try,
then come back and we'll see how you did,
and I'll meet you over that light board.
And we're back.
It's getting better and better, isn't it?
We're getting better and better at it.
Okay, we're trying here to decide whether or not to keep or
drop the product line of premium wicker with baskets.
So, let's think about this.
We have two alternatives.
Alternative one is to keep the baskets.
Alternative two is to drop the product line.
So, let's list our two alternatives here,
and so we can do our financial analysis.
Now, let's think about this.
If we keep the product line,
then the revenues that we're generating will stay as is.
We won't see any change.
The cost that we're generating will stay the same.
We won't see any change. And so,
we'll see no change in profit.
We still will see the same profit result that we've been seeing.
But if we drop the product line,
what we will see happen is that we will forego
the revenues that that product line was generating,
but we'll also avoid some costs associated with that product line,
so profit will either go up or down depending on whether
the revenues we give up are higher or lower than the costs that we would avoid.
So, let's take a look here.
Here, we have the information from the accounting system about
the revenues and costs associated with this premium wicker basket product line.
The revenues this product line is generating $350,000.
If we discontinue the product line,
no longer we'll have the benefit of those revenues.
So, we will lose $350,000 in revenue.
Now, that could be okay.
If we're able to avoid incurring more costs than that,
then it would be worth giving it up. Let's take a look.
I believe the managers decided that.
They didn't think there was any way they were going to be able to
reduce the fixed costs that the organization was incurring.
So, the only thing that we would avoid in the way of cost would be the variable cost.
And here, those variable costs total $200,000.
Okay. So, if we discontinue the product line,
our cost will be lower by $200,000.
So, that will be a benefit to us.
So, we give up 150,000 in revenues in exchange for avoiding 200,000 in cost.
So, that looks to me like our profit would decrease by $150,000.
We'd give up more revenues,
then we would be able to avoid costs.
So, that would suggest that we don't want to drop the product line.
We're better off keeping it.
