Douglas Corporation Produces and Sells Three Products Management Has Expressed Special Concern with the Regional Market Because

Essay

Douglas Corporation produces and sells three products. The three products, Alpha, Beta, and Gamma, are sold in a local market and in a regional market. At the end of the first quarter of the current year, the following income statement (in thousands of dollars) has been prepared:
$\begin{array}{lrrrr}&\text {Total}&\text {Local}&\text {Regional}\\\text { Sales revenue } & \$ 5,200 & \$ 4,000 & \$ 1,200 \\\text { Cost of goods sold } & 4,040 & 3,100& 940\\\text { Gross margin } & 1,160 & 900& 260\\\text { Marketing costs}&420&240&180\\\text { Administrative costs}&208&160&48\\\text { Operating profits}&\$532&\$500&\$32\end{array}$

Management has expressed special concern with the regional market because of the extremely poor return on sales. This market was entered a year ago because of excess capacity. It was originally believed that the return on sales would improve with time, but after a year, no noticeable improvement can be seen from the results as reported in the above quarterly statement. In attempting to decide whether to eliminate the regional market, the following information has been gathered:
$$\begin{array} { l r r r r } { \text { Products } } & \text { Alpha } & \text { Beta } & { \text { Gamma } } \\\text { Sales reveruse } & \$ 2,000 & \$ 1,600 & \$ 1,600 \\\text { Variable manufacturing cost\% of sales } & 60 \% & 70 \% & 60 \% \\\text { Variable marketing cost } & 3 \% & 2 \% & 2 \%\end{array}$$
$$\begin{array} { l r r r } & \text { Product Sales by Markets } & \text { Local } & \text { Regional } \\\text { Alpha } && \$ 1,600 & \$ 400 \\\text { Beta } && 1,200 & 400 \\\text { Gamma } && 1,200 & 400\end{array}$$
All administrative costs and fixed manufacturing costs are common to the three products and the two markets and are fixed for the period. Remaining marketing costs are fixed for the period and separable by market. All fixed costs have been arbitrarily allocated to markets.
Required:
a. Assuming there are no alternative uses for the Douglas Corporation's present capacity, would you recommend dropping the regional market? Why or why not?
b. Prepare the quarterly income statement showing contribution margins by products. Do not allocate fixed costs to products.
c. It is believed that a new product can be ready for sale next year if the Douglas Corporation decides to go ahead with continued research. The new product can be produced by simply converting equipment presently used in producing product Gamma. This conversion will increase fixed costs by $40,000 per quarter. What must the minimum contribution margin per quarter be for the new product to make the changeover financially feasible?