Problem 4-65 (Algo) Decision Whether to Add or Drop (LO 4-4) Hazlett & Family is organized into two geographic markets Northern and Southern. The company makes an off-road vehicle for recreation and agricultural use. The vehicle is sold in three models, depending on the power and options. The three models, from least expensive to most expensive, are the H-L, H-LX, and H-LXS. The company's financial staff has prepared the following forecasted income statement for the upcoming fiscal year (in thousands of dollars): Total Northern Southern Sales revenue $ 61,200 $ 46,350 $ 14,850 Cost of goods sold 47,250 35,775 11,475 Gross margin $ 13,950 $ 10,575 $ 3,375 Marketing costs 5,175 2,925 2,250 Administrative costs 2,583 2,025 558 Total marketing and administrative $ 7,758 $ 4,950 $ 2,808 Operating profits $ 6,192 $ 5,625 $ 567 Management has expressed special concern with the Southern market because of the extremely poor return on sales. This market was entered a year ago because it seemed like the best opportunity for growth. Hazlett & Family knew that it would take some time to build profitability in the market, but there has been no noticeable change in the low returns over time. The financial staff has also prepared product-line information to help the managers of the company decide whether to leave the Southern market. Products H-L H-LX H-LXS Sales revenue $ 23,400 $ 18,900 $ 18,900 Variable manufacturing costs as a percentage of sales revenue 50% 75% 65% Variable marketing costs as a percentage of sales revenue 5 2 3 Sales revenue by market and product are as follows (in thousands of dollars): Northern Southern H-L $ 18,900 $ 5,400 H-LX 14,400 5,400 H-LXS 14,400 5,400 Marketing costs that are not listed as variable are fixed for the period and separable by market. Fixed marketing costs assigned to the Southern market would be saved if that market were eliminated. Eliminating the Southern market will not affect administrative costs or fixed manufacturing costs. Required: a. Assuming there are no alternative uses for Hazlett & Family's present capacity, would you recommend dropping the Southern market? b. Prepare the forecasted annual income statement showing contribution margins by products. Do not allocate fixed costs to products. c. It is believed that a new model can be ready for sale next year if Hazlett decides to go ahead with continued research. The new product would replace H-LX and can be produced by simply converting equipment presently used in producing the H-LX model. This conversion will increase fixed costs by $468,000 annually. What must be the minimum annual contribution margin for the new model to make the changeover financially feasible?