Cornerstone Exercise 17.2 (Algorithmic) Keep-Or-Drop Decision, Alternatives, Relevant Costs

Reshier Company makes three types of rug shampooers. Model 1 is the basic model rented through hardware stores and supermarkets. Model 2 is a more advanced model with both dry-and wet-vacuuming capabilities. Model 3 is the heavy-duty riding shampooer sold to hotels and convention centers. A segmented income statement is shown below.

		Model 1		Model 2		Model 3		Total
Sales		$260,000		$598,000		$610,500		$1,468,500
Less variable costs of goods sold		(85,500)		(170,680)		(336,800)		(592,980)
Less commissions		(5,400)		(30,000)		(21,000)		(56,400)
Contribution margin		$169,100		$397,320		$252,700		$819,120
Less common fixed expenses:
Fixed factory overhead								(375,000)
Fixed selling and administrative								(291,000)
Operating income								$153,120

While all models have positive contribution margins, Reshier Company is concerned because operating income is less than 10 percent of sales and is low for this type of company. The companys controller gathered additional information on fixed costs to see why they were so high. The following information on activities and drivers was gathered:

						Driver Usage by Model
Activity	Activity Cost				Activity Driver	Model 1				Model 2				Model 3
Engineering		$78,000			Engineering hours		730				76				194
Setting up		183,000			Setup hours		12,100				12,200				29,194
Customer service		103,000			Service calls		13,400				1,480				19,194

In addition, Model 1 requires the rental of specialized equipment costing $20,500 per year.

2. Using your answer to Requirement 1, assume that Reshier Company is considering dropping any model with a negative product margin. What are the alternatives?

Keeping Model 1 or dropping it

Which alternative is more cost effective and by how much? (Assume that any traceable fixed costs can be avoided.) Do NOT round interim calculations and, if required, round your answer to the nearest dollar.

Dropping Model 1 will add $9,761 to operating income

3. What if Reshier Company can only avoid 188 hours of engineering time and 5,500 hours of setup time that are attributable to Model 1? How does that affect the alternatives presented in Requirement 2? Which alternative is more cost effective and by how much? Do NOT round interim calculations and, if required, round your answer to the nearest dollar.

will add $ to operating income - CAN'T FIGURE OUT #3

Reshier Company Segmented Income Statement Model 1 Model 2 Model 3 Total Sales 260000 598000 610500 1468500 Less variable cost of go 85500 -170680 -336800 592980 Less commIssIons 5400 -30000 -21000 56400 Contribution margin 169100 397320 252700 819120 Less traceable fixed expenses: Engineering 56940 5928 15132 78000 Setting up 41393 41736 99871 183000 Equipment rental 20500 20500 Customer service 40506 4474 58020 103000 Product margin 9761 345182 79677 434620 Less common fixed expenses: Factory overhead 93500 Selling and admin. expe -188000 Operating income 153120