The Draper Corporation is considering dropping its Doombug toy due to continuing losses. Data on the toy for the past year follow:

The Draper Corporation is considering dropping its Doombug toy due to continuing losses. Data on the toy for the past year follow:

Sales of 15,000 units	$	150,000
Variable expenses		120,000
Contribution margin		30,000
Fixed expenses		40,000
Net operating loss	$	(10,000	)

If the toy were discontinued, Draper could avoid $8,000 per year in fixed costs. The remainder of the fixed costs are not avoidable.

Suppose that if the Doombug toy is dropped, the production and sale of other Draper toys would increase so as to generate a $16,000 increase in the contribution margin received from these other toys. If all other conditions are the same, the financial advantage (disadvantage) from discontinuing the production and sale of Doombugs would be:

Multiple Choice

• ($6,000)

  Correct
• $14,000
• ($2,000)
• $28,000

Explanation

Sales	$	150,000
Variable expenses		120,000
Contribution margin		30,000
Avoidable fixed expenses		8,000
Profit from Doombugs	$	22,000

However, even though the nominal profit from Doombugs is $22,000, dropping the product would increase the contribution margin received from other toys by $16,000. Therefore, the net effect on net operating income would be a $6,000 decrease (–$22,000 + $16,000).