Decision Making
By Ghanendra Fago
Drop Or Continue Product Line Decision
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When a firm or company is divided into many departments, divisions,
sections, branches and product lines to produce and sell various types
of product, it is not necessary for earning profit by each product line,
division, department, and branch.
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In case of loss or low profit from one or more, management should
taken decision whether to drop or continue product line in the future.
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The management should take decision based on the segment margin
of the department or division, or product line which is the basic criteria
whether to drop or continue decision.
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Segment margin is the margin which can be obtained deducting
departmental fixed cost/segment fixed/traceable fixed cost from
contribution margin of the department/ product line/ division.
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To take decision drop or continue product line, segment margin should
be taken as basis of criteria. If the segment margin is greater than
zero, then it will be better to continue and if more than zero, better to
drop the product line.
Factors considerations
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While taking drop or continue product line decision, it is very
important to consider the following points.
Alternative utilization of idle capacity like machine, labour, land etc.
Continuity of constant cost/fixed cost
Departmental or traceable fixed cost
Opportunity cost
Government rules and regulation regarding drooping product
Union activity
Effect on other product lines
Response of material suppliers
Regular customers etc.
CASE The Regal Cycle Company manufactures three types of
bicycles – a dirt bike, a 10 speed bike, and a touring bike. Data on
sales and expenses for the past six months follow:
Particulars
Total Dirt bikes 10–speed Touring
bikes
bikes
Sales
Less: Variable manufacturing &
selling expenses
Contribution margin
$ 300,000
120,000
$ 90,000 $ 150,000 $ 60,000
27,000
60,000
33,000
180,000
63,000
90,000
27,000
30,000
23,000
35,000
60,000
10,000
6,000
12,000
18,000
14,000
9,000
13,000
30,000
6,000
8,000
10,000
12,000
Total fixed expenses
148,000
46,000
66,000
36,000
Net income (loss)
$ 32,000
$ 17,000
Less: Fixed expenses:
Advertising, direct
Depreciation
of
special
equipment
Salary
of
line
supervisor
Common,
but
allocated*
$ 24,000 $ (9,000)
Management is concerned about the continued losses
shown by the touring bikes and wants a
recommendation as to whether or not the line should
be discontinued. The special equipment used to
produce touring bikes has no resale value.
Required:
Should production and sale of the touring bikes be
discontinued? Show computations to support your
answer.
CASE 2: A discount department has three major departments:
Groceries, General Merchandise and Drugs. The department is
thinking of dropping the Groceries departments which has constantly
shown a net loss. The present annual net income of the store is as
follows: in Thousands)
]
Sales
Variable
expenses
cost
and
Contribution margin
Groceries
General
Merchandi
se
Drugs
Total
$. 1,000
$. 800
800
560
60
1,420
200
240
40
480
150
100
15
265
60
100
20
180
210
200
35
445
$. 100 $. 1,900
Fixed costs:
Separable
Joint
allocated
Total fixed cost
but
Required:
1. Which alternative would you recommend either to
drop or continue the grocery department? Assume
that the total assets invested will not be affected
by decision. Also assume that the vacated space
will be idle.
2. Should the groceries department be closed under
the condition that the space made available by the
dropping of groceries would be used by an
expanded G. Merchandise Department? The
sales will be increase by $ 500, generates a 30%
contribution margin and have separable fixed
costs of $ 70 by doing it.