Momentum Rollerblades has three product lines: D, E, and F. The following information is available:

D E F
Sales revenue $90,000 $40,000 $30,000
Variable costs (40,000) (10,000) (10,000)
Contribution margin $50,000 $30,000 $20,000
Fixed costs (10,000) (5,000) (25,000)
Operating income (loss) $40,000 $25,000 ($5,000)

The company is deciding whether to drop product line F because it has an operating loss. Assume that $21,000 of total fixed costs could be eliminated by dropping F. What effect would this decision have on operating income?

A. Operating income will decrease by $2000.

B. Operating income will increase by $24,000.

C. Operating income will decrease by $24,000.

D. Operating income will increase by $2000.

Operating income will increase by $16,000. This is not given as one of the options.

Explanation:

The difference between the sales and variable expense gives the contribution margin. The contribution margin net the fixed cost gives the operating income or loss.

                                                     D                         E                    F

Sales revenue                            $90,000        $40,000        $30,000

Variable costs                            ($40,000)      ($10,000)       ($10,000)

Contribution margin                   $50,000        $30,000        $20,000

Fixed costs                                 ($10,000)       ($5,000)       ($25,000)

Operating income (loss)             $40,000         $25,000       ($5,000)

The total operating income is

= $40,000 + $25,000 + ($5,000)

= $60,000

Should the fixed costs of F be eliminated, the operating income/(loss) of F

= $21,000 - $5,000

= $16,000

This is the net increase in the total operating income.

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