For the drop or add question, we look now a clock company. Lovell Comp any makes all sorts of different time pieces, but the digital watches are not very popular. Most people just use their cell phones or use pretty analog watches instead. The company is considering dropping the digital watch line because it hasn't been making any money.
-This isn't a simple evaluation because there are operating costs that are shared across multiple product lines. For instance, there is only one factory, on which rent must be paid. That rent cost is allocated between the various products, but eliminating digital watches won't necessarily save rent. For each of our different scenarios there will be different details. We need to base our decisions on the information provided, although we know that there are other potential areas that need to be considered.
In this case, we are told that the "general factory overhead" and "fixed general administrative expenses" will not change if we drop the digital watch line. In other words, these costs are NOT avoidable.
- Looking at the
particulars for the digital watch line, we see that it is generating $300,000 of contribution margin, but it has $400,000 of expenses. We need to see what of these benefits and costs will change if the product is dropped. If we eliminate digital watches, it means we won't sell any. If we know we won't be selling them, we won't bother to build any. That means that all variable costs and benefits will be zero. Contribution margin will be zero.
Next we need to look at the fixed costs. We know from the previously provided information that the general overhead isn't going to change. In other words, we will still have to pay that cost even if we stop selling digital watches.
-In contrast, the salary of the line manager would be a savings, as that guy got fired. He was terrible. Depreciation, on the other hand, will not be a savings. Remember it is just an allocation of an amount we already spent, its cost must continue to be accounted for.
-We aren't going to advertise for a product we aren't selling, so we will save the direct advertising. We will also save the factory rent costs in this case ,since we aren't told that we must continue to use the space. Presumably, the lease is up for renewal and we can stop renting the property if we stop making the watches. Lastly, we come to the general administrative expenses, which we have been told will not change. Therefore, we have to continue paying that $30,000. Overall, we see that Lovell see a net loss of $140,000 if the company stops making the watches, whereas it has a net loss of only $100,000 with the watches. It is a bad plan to stop making the watches.
1.The Lovell Company drop or add decision is in your chapter materials. The text has us making this determination based solely on the financial implications. What other factors should be considered when making the decision you choose?
please provide two externalities that the company management should consider and explain why the factors impact the decision. Keep in mind that externalities are not costs that the company would normally be tracking.
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