Diamond Company has three product lines, A, B, and C. The following financial information is available:Diamond is thinking of dropping Product Line C because it is reporting an operating loss. Assuming the company drops Product Line C and does not replace it, pre-tax operating income for the firm will likely:
A) Be unchanged
B) Increase by $1,200
C) Increase by $1,500
D) Decrease by $1,500
E) Decrease by $2,700

Question

Diamond Company has three product lines, A, B, and C. The following financial information is available:Diamond is thinking of dropping Product Line C because it is reporting an operating loss. Assuming the company drops Product Line C and does not replace it, pre-tax operating income for the firm will likely:
A) Be unchanged 
B) Increase by $1,200 
C) Increase by $1,500 
D) Decrease by $1,500 
E) Decrease by $2,700

Quizplus · Accepted Answer

Dropping Product Line C will result in a decrease in revenue of $4,500 (the current revenue of Product Line C). However, this will also result in a decrease in cost of goods sold of $3,100 (the current cost of goods sold of Product Line C) and a decrease in operating expenses of $900 (the current operating expenses of Product Line C).

Therefore, the total decrease in expenses will be $4,000 (3,100 + 900). The decrease in revenue will be greater than the decrease in expenses, resulting in a decrease in pre-tax operating income of $500 (4,500 - 4,000). So, the answer is D, pre-tax operating income for the firm will decrease by $1,500.

Diamond Company Has Three Product Lines, A, B, and C