Royal Company makes two types of carpet cleaners. Model 1 is the basic model and is sold through supermarkets. Model 2 is a heavy-duty model which is sold mainly to hotels and home centres. More information is provided below:

Model 1

Model 2

Total

Sales

$245,000

$532,000

$777,000

Variable costs

$60,000

$230,000

$290,000

Fixed costs:

Direct fixed costs

$90,000

$202,000

$292,000

Allocated common fixed costs

$33,000

$66,000

$99,000

Royal Company is concerned about Model 1 because it is making the company operate at a loss. Accordingly, the management of the company is considering to discontinue Model 1. If Model 1 is dropped 30% of its direct fixed costs can be avoided.

Required:

1) Explain the basis of the decision rule upon which the company would decide whether to keep or discontinue Model 1 of the carpet cleaners. (1 Mark)

2) What will be the financial advantage (disadvantage) of dropping Model 1? Would you recommend Royal Company to keep or discontinue Model 1? Explain why. (1.5 Marks)

3) Assume that if Model 1 is discontinued, the sales and variable costs of Model 2 will drop by 10% and 5% of the allocated common fixed costs of Model 1 can be avoidable. In this case would you recommend that Royal Company discontinue Model 1? Explain why. (1.5 Marks)

4) Based on your answer in requirement (3), what would be the amount of irrelevant costs which are related to the decision of dropping Model 1? (1 Mark)

MigatCoterenyiscearstret Bmeins