Question 2 Relevant Costs

A company has the following three divisions. Overall, the company is profitable but is concerned about the Hats Division. The Hats Division adds diversification of product lines but has an operating profit loss. The Board of Directors is very concerned about the loss as it is over 36% of total operating profit. A large part of the costs are sales persons costs, particularly variable commissions on sales. The company is unaware of how competitors pay commssions and the level of commissions. But the Board says the loss needs to be fixed and maybe the division should be closed. But under no circumstances should the total operating profits of the company be below $2,000. The financial forecast of all divisions follows.

Questions:

1. What type of specific analysis is the above example? (1 mark)

2. Use quantitative analysis to assess whether the company should close the Hats Division. (13 marks)

3. What is an important strategic consideration in making the above decision? (1 mark)

Shoes 10,000 Shirts 5,000 Hats 2,500 Total 17,500 Sales Cost of Goods Sold (COGS) Variable Fixed Total COGS Gross Profit Corporate Variable Expenses Corporate Fixed Expenses Opearting Profit 3,000 2,000 5,000 5,000 1,000 2,000 2,000 1,500 1,000 2,500 2,500 500 1,000 1,000 750 500 1,250 1,250 1,250 800 800 5,250 3,500 8,750 8,750 2,750 3,800 2,200