Question

Stephens, Inc. is considering dropping a product line. During the prior year, the line had sales of $170,000, variable costs of $86,000, and total fixed expenses of $110,000. Of the fixed expenses, $95,000 are avoidable. If Stephens drops the product line, net operating income will Blank______.

Multiple choice question.

increase by $9,000


increase by $26,000


decrease by $60,000


increase by $11,000

Answer 1

To determine the impact on net operating income if Stephens, Inc. drops the product line, we need to analyze the contribution margin and the impact of avoidable fixed expenses.

1. **Calculate Contribution Margin:**
- Sales: $170,000
- Variable Costs: $86,000
- Contribution Margin = Sales - Variable Costs = $170,000 - $86,000 = $84,000

2. **Identify Avoidable Fixed Expenses:**
- Total Fixed Expenses: $110,000
- Avoidable Fixed Expenses: $95,000
- Therefore, if the product line is dropped, $95,000 of the fixed expenses will be eliminated.

3. **Calculate Change in Net Operating Income:**
- If the product line is dropped, the company will lose the contribution margin of $84,000 but will also save the avoidable fixed expenses of $95,000.
- Impact on Net Operating Income = Avoidable Fixed Expenses - Contribution Margin
- Impact = $95,000 (savings) - $84,000 (loss) = $11,000

This indicates that if Stephens drops the product line, net operating income will **increase by $11,000**.

Therefore, the correct answer is:
**increase by $11,000**.