If the company had dropped Product 103 as of January 1, 1974, what effect would that action have had on the $160,000 profit for the first six months of 1974?
The company is currently selling Product 103 for $5.41 (after discounts), which is below cost ($5.83). The variable costs (which would go away if the product was removed) are direct labor, compensation insurance, materials, power, supplies, and repairs, which equate to $2.62 per cwt/unit. The fixed costs (which would remain) are rent, property taxes, property insurance, indirect labor, light and heat, building service, selling expense, general administrative, interest, other income, cash discount, and depreciation, which equates to $3.21 per cwt/unit. Therefore, if the Product 103 price is $5.41 and the variable costs are $2.62, then the unit contribution margin is $2.79. If Hanson Manufacturing dropped Product 103 on January 1st, 1974, the company would still have $1,609,597.24 in fixed costs, which would crush the company’s profitability (resulting in a loss of $1,449,597.24). See Exhibit 4 for numbers.
In January 1975, should the company have reduced the price of Product 101 from $4.90 to $4.50?
Yes. If you look at the unit contribution margin and the volume increase, then the price reduction makes sense. The variable costs for Product 101 are $2.09 per cwt/unit. The contribution margin for the $4.90 price equals $2.81. If you multiply the $2.81 contribution margin by the volume (750,000) for the $4.90 price you get $2,104,800. The contribution margin for the $4.50 price equals $2.41. If you multiply the $2.41 contribution margin by the volume (1,000,000) for the $4.50 price you get $2,410,000. Assuming Wessling is correct about the volume forecast, then the reduction in price to $4.50 makes the most sense for profitability. See Exhibit 4 for numbers.
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