DM Company has provided you with the following budgeted income statement for one of their products:
$$\begin{array} { | l | l | }
\hline \text { Sales } & \$ 700,000 \
\hline \text { Variable expenses } & ( 430,000 ) \
\hline \text { Contribution margin } & \$ 270,000 \
\hline \text { Fixed expenses } & ( 300,000 ) \
\hline \text { Operating loss } & ( \$ 30,000 ) \
\hline
\end{array}$$
DM has just encountered environmental problems with the product and will be forced to drop the product line altogether.They will be able to eliminate 75% of the fixed expenses.What will be the impact on operating profit of the company?

Question

DM Company has provided you with the following budgeted income statement for one of their products:
$$\begin{array} { | l | l | } 
\hline \text { Sales } & \$ 700,000 \
\hline \text { Variable expenses } & ( 430,000 ) \
\hline \text { Contribution margin } & \$ 270,000 \
\hline \text { Fixed expenses } & ( 300,000 ) \
\hline \text { Operating loss } & ( \$ 30,000 ) \
\hline
\end{array}$$
DM has just encountered environmental problems with the product and will be forced to drop the product line altogether.They will be able to eliminate 75% of the fixed expenses.What will be the impact on operating profit of the company?

Quizplus · Accepted Answer

From the income statement, we can see that operating profit is $300,000. If the company drops the product line and is able to eliminate 75% of fixed expenses, then the new fixed expenses will be $150,000 (25% of $600,000). 
Thus, the new operating profit will be $150,000 ($450,000 - $150,000), which is a decrease of $150,000 from the original operating profit of $300,000. 
Therefore, the answer is D - Operating profit will decrease by $45,000 (not $225,000).

DM Company Has Provided You with the Following Budgeted Income