A study has been conducted to determine if Product A should be dropped. Sales of the product total $400,000 per year; variable expenses total $270,000 per year. Fixed expenses charged to the product total $160,000 per year. The company estimates that $70,000 of these fixed expenses are not avoidable even if the product is dropped. If Product A is dropped, the company's overall net operating income would:
A)decrease by $40,000 per year
B)increase by $40,000 per year
C)decrease by $30,000 per year
D)increase by $30,000 per year

Question

Quizplus · Accepted Answer

Currently, the net operating income (NOI) for Product A can be calculated as follows:

NOI = Sales - Variable expenses - Fixed expenses
NOI = $400,000 - $270,000 - $160,000
NOI = $-30,000 (i.e. a loss)

If Product A is dropped, the variable expenses and $90,000 of the fixed expenses would cease. However, $70,000 of the fixed expenses are not avoidable and would still be incurred even without Product A. Therefore, the new NOI for the company would be:

NOI = Sales - Variable expenses - Fixed expenses
NOI = $0 - $0 - ($70,000 + $90,000)
NOI = $-160,000 (i.e. a loss)

This means that dropping Product A would decrease the company's overall NOI by $130,000 per year ($160,000 loss without Product A minus $30,000 loss with Product A). Therefore, the best answer is A - decrease by $40,000 per year.

A Study Has Been Conducted to Determine If Product a Should