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MCQ-12091

A company manufactures three products, T1, T2, and T3. Their financial information is shown
below:

T1 T2 T3

Sales $60,000 $90,000 $24,000

Variable costs 36,000 48,000 15,000

Contribution margin 24,000 42,000 9,000

Fixed costs:

Avoidable 9,000 18,000 6,000

Unavoidable 6,000 9,000 5,400

Operating income $9,000 $15,000 ($2,400)

Management is concerned about the financial performance of T3. If the company drops the T3
product line, the operating income will:

A. Increase by $2,400.

B. Decrease by $3,000.

C. Increase by $3,000.

D. Decrease by $9,000.

Explanation

Choice "B" is correct. This question addresses a continuation-of-a-product-line decision. Because

the product is earning a negative operating income, at first glance, it appears that this product line
should be eliminated. However, the analysis should focus only on the costs that are relevant (that
is, costs that will change if the product line is discontinued). The costs that do not change are not
part of the decision-making process.
If T3 is eliminated, the company will no longer receive the T3 contribution margin of $9,000, but
only $6,000 of avoidable fixed costs will be eliminated. So, if the T3 is eliminated, the company's
operating income will fall by $3,000: $9,000 contribution margin no longer received, but only
$6,000 of fixed costs will be eliminated.

Choice "A" is incorrect. Eliminating T3 will not increase income by $2,400, because only the
contribution margin and avoidable fixed costs are removed. The $5,400 unavoidable fixed costs
will continue and will be absorbed as part of the costs to make the other two products.

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11/7/22, 9:38 PM Find Question

Choice "C" is incorrect. This choice assumes that the elimination of $9,000 of contribution margin
and $6,000 of avoidable fixed costs will increase income by $3,000 ($9,000 – $6,000). However, if
T3 is eliminated, the company will no longer receive the T3 contribution margin of $9,000, but
only $6,000 of avoidable fixed costs will be eliminated. The result is a $3,000 net decrease, not a
net increase, in the company's operating revenue.

Choice "D" is incorrect. If T3 is eliminated, the company will lose the $9,000 contribution margin,
which results in a decrease to income. However, this $9,000 decrease to income is partially offset
by the $6,000 decrease in the avoidable costs. The net effect is a $3,000 decrease, not a $9,000
decrease, in the company's operating income.

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