Prince Company's racquet division has projected a net operating loss of $190,000 for the upcomingyear; fixed costs for the racquet division total $325,000, of which $115,000 are considered to beavoidable. As a result of the forecasted loss, Prince is considering dropping the racquet division.If the racquet division is dropped, Prince estimates that the clothing division's sales will decrease 5%next year. The clothing division's projected operating income next year is $195,000 while theprojected contribution margin is $525,000. Should Prince Company drop the racquet division?

Question

Quizplus · Accepted Answer

No, because operating income will decrease $46,250.Dropping the racquet division would eliminate its $190,000 loss, but only $115,000 of the division's fixed costs are avoidable, leading to a net savings of $115,000. However, the 5% decrease in the clothing division's sales due to dropping the racquet division would reduce its contribution margin ($525,000) by 5%, or $26,250, and thus reduce operating income by the same amount. Therefore, the net effect on operating income would be a decrease of $46,250 ($115,000 savings - $26,250 loss in contribution margin from the clothing division).

Prince Company's Racquet Division Has Projected a Net Operating Loss