Decide whether to drop a product line (Learning Objective 4)

Top managers of Video Avenue are alarmed by their operating losses. They are consid¬ ering dropping the VCR-tape product line. Company accountants have prepared the following analysis to help make this decision:

Total fixed costs will not change if the company stops selling VCR tapes.
Requirements 1. Prepare an incremental analysis to show whether Video Avenue should drop the VCR-tape product line. Will dropping VCR tapes add $30,000 to operating income? Explain.
2. Assume that Video Avenue can avoid $30,000 of fixed expenses by dropping the VCR-tape product line (these costs are direct fixed costs of the VCR product line). Prepare an incremental analysis to show whether Video Avenue should stop selling VCR tapes.
3. Now, assume that all $70,000 of fixed costs assigned to VCR tapes are direct fixed costs and can be avoided if the company stops selling VCR tapes.
However, marketing has concluded that DVD sales would be adversely affected by discontinuing the VCR line (retailers want to buy both from the same supplier). DVD production and sales would decline 10%. What should the company do?

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DVD VCR Total Discs Tapes Sales revenue $420,000 $300,000 $120,000 Variable expenses 230,000 150,000 80,000 Contribution margin 190,000 150,000 40,000 Fixed expenses: Manufacturing 125,000 70,000 55,000 Marketing and administrative 70,000 55,000 15,000 Total fixed expenses 195,000 125,000 70,000 Operating income (loss) $ (5,000) $ 25,000 $ (30,000)