Morning Sky, Inc. (MSI), manufactures and sells computer games.The company has several product lines based on the age range of thetarget market. MSI sells both individual games as well as packagedsets. All games are in CD format, and some utilize accessories suchas steering wheels, electronic tablets, and hand controls. To date,MSI has developed and manufactured all the CDs itself as well asthe accessories and packaging for all of its products.
The gaming market has traditionally been targeted at teenagersand young adults; however, the increasing affordability ofcomputers and the incorporation of computer activities into juniorhigh and elementary school curriculums has led to a significantincrease in sales to younger children. MSI has always includedgames for younger children but now wants to expand its business tocapitalize on changes in the industry. The company currently hasexcess capacity and is investigating several possible ways toimprove profitability.
MSI is considering eliminating a product from its ToddleTownTours collection. This collection is aimed at children one to threeyears of age and includes “tours” of a hypothetical town. Twoproducts, The Pet Store Parade and The Grocery Getaway, haveimpressive sales. However, sales for the third CD in thecollection, The Post Office Polka, have lagged the others. Severalother CDs are planned for this collection, but none is ready forproduction.
MSI’s information related to the ToddleTown Tours collectionfollows:
| Segmented Income Statement for MSI’s |
| ToddleTown Tours Product Lines |
| Pet Store Parade | | Grocery Getaway | | Post Office Polka | | | Total |
| Sales revenue | $ | 135,000 | | $ | 130,000 | | $ | 36,000 | | | $ | 301,000 |
| Variable costs | | 57,000 | | | 53,000 | | | 32,000 | | | | 142,000 |
| Contribution margin | $ | 78,000 | | $ | 77,000 | | $ | 4,000 | | | $ | 159,000 |
| Less: Direct Fixed costs | | 8,200 | | | 8,200 | | | 3,400 | | | | 19,800 |
| Segment margin | $ | 69,800 | | $ | 68,800 | | $ | 600 | | | $ | 139,200 |
| Less: Common fixed costs* | | 6,750 | | | 6,500 | | | 1,800 | | | | 15,050 |
| Net operating income (loss) | $ | 63,050 | | $ | 62,300 | | $ | (1,200 | ) | | $ | 124,150 |
|
*Allocated based on total sales dollars.
MSI has determined that elimination of the Post Office Polka (POP)program would not impact sales of the other two items. Theremaining fixed overhead currently allocated to the POP productwould be redistributed to the remaining two products.
Required:
1. Calculate the incremental effect on profit if the POPproduct is eliminated.
2. Should MSI drop the POP product?
3-a. Calculate the incremental effect on profit ifthe POP product is eliminated. Suppose that $1,200 of the commonfixed costs could be avoided if the POP product line wereeliminated.
3-b. Should MSI drop the POP product?
