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SOLUTION
(25 min.) Closing down divisions.
1. and 2.
Division A Division B
Sales $504,000 $948,000
Variable costs of goods sold
($440,000
´
0.90; $930,000
´
0.80)
Division A Division B
Fixed costs of goods sold
($440,000 ´ 0.10; $930,000 ´ 0.20) $ 44,000 $186,000
Fixed S,G & A
Division A’s contribution margin of $60,000 more than covers its avoidable fixed costs of
$36,800. The difference of $23,200 helps the company recover unavoidable fixed costs.
Because $36,800 of Division A’s fixed costs are avoidable, the remaining $55,200 ($92,000 −
$36,800) is unavoidable and will be incurred regardless of whether Division A continues to
Division B earns a positive contribution margin of $102,750. Division B also generates
An alternative set of calculations is as follows:
Division A Division B
Total variable costs $444,000 $845,250
11-9
3. Before deciding to close Division B, management should consider the role that the
Division’s product line plays relative to other product lines. For instance, if the product
11-47 Dropping a product line, selling more tours. Nelson River Tours, a division of Old
World Travel, offers two types of guided fishing tours, Beginner and Advanced. Operating
income for each tour type in 2017 is as follows:
The equipment has a zero disposal value. Guide wages, supplies, and vehicle fuel are
variable costs with respect to the number of tours. Administrative salaries are fixed costs
with respect to the number of tours. Dennis Baldwin, Nelson River Tours’ president, is
concerned about the losses incurred on the Advanced tours. He is considering dropping the
Advanced tour and offering only the Beginner tour.
Required:
1. If the Advanced tours are discontinued, one administrative position could be eliminated,
saving the company $100,000. Assuming no change in the sales of Beginner tours, what
effect would dropping the Advanced tour have on the company’s operating income?
2. Refer back to the original data. If Nelson River Tours drops the Advanced tours, Baldwin
estimates that sales of Beginner tours would increase by 50%. He believes that he could still
eliminate the $100,000 administrative position. Equipment currently used for the Advanced
tours would be used by the additional Beginner tours. Should Baldwin drop the Advanced
tour? Explain.
11-9
3. What additional factors should Baldwin consider before dropping the Advanced tours?
SOLUTION
(30 min.) Dropping a product line, selling more tours
1. Baldwin should not drop the advanced tours, as follows:
Note: Equipment depreciation, allocated corporate costs, and unavoidable administrative salaries
are irrelevant to the decision.
2. Baldwin should drop the advanced tours, as follows:
3. Baldwin should consider if it is possible to increase the number of advanced tours sold, or
if it is possible to reduce the costs of those tours before dropping them. He could also investigate
the possibility of increasing the price of the advanced tours if customers would tolerate it.
11-48 Optimal product mix. (CMA adapted) Della Simpson, Inc., sells two popular brands of
cookies: Della’s Delight and Bonny’s Bourbon. Della’s Delight goes through the Mixing and
Baking departments, and Bonny’s Bourbon, a filled cookie, goes through the Mixing, Filling, and
Baking departments.
Michael Shirra, vice president for sales, believes that at the current price, Della Simpson can
sell all of its daily production of Della’s Delight and Bonny’s Bourbon. Both cookies are made in
batches of 3,000. In each department, the time required per batch and the total time available
each day are as follows:
Revenue and cost data for each type of cookie are as follows:
11-9
Required:
1. Using D to represent the batches of Della’s Delight and B to represent the batches of Bonny’s
Bourbon made and sold each day, formulate Shirra’s decision as an LP model.
2. Compute the optimal number of batches of each type of cookie that Della Simpson, Inc.,
should make and sell each day to maximize operating income.
SOLUTION
(30–40 min.) Optimal product mix.
1. Let D represent the batches of Della’s Delight made and sold.
Let B represent the batches of Bonny’s Bourbon made and sold.
The LP formulation for the decision is:
Maximize $300D + $250 B
2. Solution Exhibit 11-48 presents a graphical summary of the relationships. The optimal
corner is the point (18, 8) i.e., 18 batches of Della’s Delights and 8 batches of Bonny’s Bourbons.
SOLUTION EXHIBIT 11-48
Graphic Solution to Find Optimal Mix, Della Simpson, Inc.
We next calculate the optimal production mix using the trial-and-error method.
The corner point where the Mixing Dept. and Baking Dept. constraints intersect can be
calculated as (18, 8) by solving:
11-9
3, 18
0, 18
0, 44
22, 0
Subtracting (2) from (1), we have
Substituting in (2)
The corner point where the Filling and Baking Department constraints intersect can be calculated
as (3,18) by substituting B = 18 (Filling Department constraint) into the Baking Department
constraint:
The feasible region, defined by five corner points, is shaded in Solution Exhibit 11-43. We next
use the trial-and-error method to check the contribution margins at each of the five corner points
of the area of feasible solutions.
Trial Corner (D,B) Total Contribution Margin
1 (0,0) ($300 0) + ($250 0) = $0
The optimal solution that maximizes contribution margin and operating income is 18 batches of
Della’s Delights and 8 batches of Bonny’s Bourbons.
11-49 Dropping a customer, activity-based costing, ethics. Justin Anders is the
management accountant for Carey Restaurant Supply (CRS). Sara Brinkley, the CRS sales
manager, and Justin are meeting to discuss the profitability of one of the customers,
Donnelly’s Pizza. Justin hands Sara the following analysis of Donnelly’s activity during the
last quarter, taken from CRS’s activity-based costing system:
11-9
Sara looks at the report and remarks, “I’m glad to see all my hard work is paying off with
Donnelly’s. Sales have gone up 10% over the previous quarter!”
Justin replies, “Increased sales are great, but I’m worried about Donnelly’s margin, Sara. We
were showing a profit with Donnelly’s at the lower sales level, but now we’re showing a loss.
Gross margin percentage this quarter was 40%, down five percentage points from the prior
quarter. I’m afraid that corporate will push hard to drop them as a customer if things don’t turn
around.”
“That’s crazy,” Sara responds. “A lot of that overhead for things like order processing,
deliveries, and sales calls would just be allocated to other customers if we dropped
Donnelly’s. This report makes it look like we’re losing money on Donnelly’s when we’re not.
In any case, I am sure you can do something to make its profitability look closer to what we
think it is. No one doubts that Donnelly’s is a very good customer.”
Required:
1. Assume that Sara is partly correct in her assessment of the report. Upon further
investigation, it is determined that 10% of the order processing costs and 20% of the
delivery costs would not be avoidable if CRS were to drop Donnelly’s. Would CRS benefit
from dropping Donnelly’s? Show your calculations.
2. Sara’s bonus is based on meeting sales targets. Based on the preceding information regarding
gross margin percentage, what might Sara have done last quarter to meet her target and
receive her bonus? How might CRS revise its bonus system to address this?
3. Should Justin rework the numbers? How should he respond to Sara’s comments about
making Donnelly’s look more profitable?
11-9
