A company currently has two product lines and is considering dropping Product XYZ. Product ABC Product XYZ
Total Sales revenue $90,000 $60,000 $150,000
Cost of goods sold (all variable) $35,000 $40,000 $75,000
Contribution margin $55,000 $20,000 $75,000
Fixed costs $30,000 $25,000 $55,000
Operating Profit (Loss) $25,000 ($5,000) $20,000

Of the $55,000 of total fixed costs, $30,000 is rent. Each product is allocated $15,000. The rent will continue even if the product is dropped. The rest of the fixed costs are related to each product and would be saved if the product was dropped.

Required:
Should Product XYZ be dropped?

Product XYZ should not be dropped. Because it is bringing a profit contribution of $5,000 towards fixed costs.

Explanation:

Calculating the Profit Contribution of Product XYZ

Sales revenue                                                                           $60,000

Less Cost of Goods Sold                                                        ($40,000)

Contribution Margin                                                                 $20,000

Less Traceable Fixed Costs  ($30,000 - $15,000)                ($15,000)

Profit Contribution                                                                      $5,000

Hint : Remove the fixed cost element centrally controlled from Product XYZ fixed costs.

Since Product XYZ is bringing a profit contribution of $5,000 towards the fixed costs, it should not be dropped.

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