Percy Productions has three models: D, E, and F. The following information is available: Percy Productions is thinking of discontinuing model F because it is reporting an operating loss. All fixed expenses are unavoidable. Assuming Percy Productions discontinues model F and does not replace it, what effect will this have on operating income?
A)Decrease $13,000
B)Increase $13,000
C)Increase $7000
D)Decrease $7000

Question

Percy Productions has three models: D, E, and F. The following information is available:  Percy Productions is thinking of discontinuing model F because it is reporting an operating loss. All fixed expenses are unavoidable. Assuming Percy Productions discontinues model F and does not replace it, what effect will this have on operating income?
A)Decrease $13,000 
B)Increase $13,000 
C)Increase $7000 
D)Decrease $7000

Quizplus · Accepted Answer

If Percy Productions discontinues model F, it will no longer have any revenues from this model but will still have to pay all of its fixed expenses. Since model F is reporting an operating loss, discontinuing it will not affect the contribution margin (revenues - variable expenses) of the company. Therefore, the entire operating loss of model F will now become an additional fixed expense for the company. Thus, the operating income would decrease by the amount of the operating loss of model F, which is $13,000.

Percy Productions Has Three Models: D, E, and F