Prince Company's racquet division has projected a net operating loss of $190,000 for the upcoming Year; fixed costs for the racquet division total $325,000, of which $115,000 are considered to be Avoidable. 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 the Projected 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 saves $115,000 in avoidable fixed costs but results in a 5% decrease in the clothing division's sales, affecting both its operating income and contribution margin. The 5% decrease in the clothing division's sales from the projected contribution margin of $525,000 equals a loss of $26,250 ($525,000 * 5%). When you subtract both the savings from dropping the division ($115,000) and the loss in sales from the clothing division ($26,250) from the initial projected net operating loss of $190,000, the net effect is a decrease in operating income of $46,250, making the correct answer C.

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