Mohave Corp. is considering eliminating a product from its Sand Trap line of beach umbrellas. This collection is aimed at people who spend time on the beach or have an outdoor patio near the beach. Two products, the Indigo and Verde umbrellas, have impressive sales. However, sales for the Azul model have been dismal.

Mohave’s information related to the Sand Trap line is shown below.

Mohave has determined that eliminating the Azul model would cause sales of the Indigo and
Verde models to increase by 10 percent and 15 percent, respectively. Variable costs for these two models would increase proportionately. Although the direct fixed costs could be eliminated, the common fixed costs are unavoidable. The common fixed costs would be redistributed to the remaining two products.

Required:
1. Will Mohave’s net operating income increase or decrease if the Azul model is eliminated? By how much?
2. Should Mohave drop the Azul model?
3. Suppose that Mohave had no direct fixed overhead in its production information and the entire $51,000 of fixed cost was common fixed cost. Would your recommendation to Mohave change? Why or whynot?

Transcribed Image Text:

Segmented Income Statement for Mohave's Sand Trap Beach Umbrella Products Indigo $60,000 34,000 $26,000 1,900 $24,100 17,840 Net operating income (lss 6,260 Verde $60,000 31,000 $29,000 7,500 $26,500 17,840 $8,660 Azul $30,000 26,000 4,000 2,000 $2,000 8,920 $ (6,920) Total $150,000 91,000 59,000 Sales revenue Variable costs Contribution margin Less: Direct Fixed costs 6,400 Segment margin Common fixed costs 52,600 44,600 $ 8,000 *Allocated based on total sales dollars