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Discussion - Example Problem of Keep or Drop Decisions

Clayton Herring is considering dropping their mud and snow (M&S) tire line which lost $25,000. While M&S tires directly lost money, only $100,000 of fixed costs could actually be avoided by dropping them. Additionally, dropping M&S tires may cause distributors to leave as the company could no longer offer a full tire product line. When deciding whether to keep or drop a product, managers should consider both quantitative financial factors and qualitative impacts to the overall business.

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Giselle Martinez
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806 views

Discussion - Example Problem of Keep or Drop Decisions

Clayton Herring is considering dropping their mud and snow (M&S) tire line which lost $25,000. While M&S tires directly lost money, only $100,000 of fixed costs could actually be avoided by dropping them. Additionally, dropping M&S tires may cause distributors to leave as the company could no longer offer a full tire product line. When deciding whether to keep or drop a product, managers should consider both quantitative financial factors and qualitative impacts to the overall business.

Uploaded by

Giselle Martinez
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Discussion - Example Problem of Keep or

Drop Decisions
The Decision to Drop  a Product or Service

 The decision to drop a product or a service is among the most difficult that a
manager can make.
 Qualitative factors are sometimes more important than focusing solely on
income.
 Let’s turn our attention to an example of dropping a product line. Clayton
Herring is thinking about dropping the mud and snow (M&S) tires.  According
to the analysis in this slide, they have a negative loss on the line of P25,000.
One of the problems is that the mud and snow tires require more machine
time to make than the other tires. Consequently, they were allocated a greater
portion of fixed overhead. However, only P100,000 of M&S’s fixed costs are
avoidable, since the machines used to make the mud and snow tires are used
on several models of tires. Should the company drop the line? 

  Mud and Snow   All Other Tires   Total 
Sales            1,275,000            7,500,000          8,775,000
Less:  Direct Materials                600,000            2,530,000          3,130,000
            Direct Labor                250,000            1,500,000          1,750,000
            Variable Overhead                100,000               600,000              700,000
Contribution Margin                325,000            2,870,000          3,195,000
Less:  Fixed Overhead                350,000            1,050,000          1,400,000
     Net Income                (25,000)            1,820,000          1,795,000
What impact will discontinuing the sale of mud and snow tires have on sales of the
remaining product lines?
Clayton Herring may lose distributors, since they cannot provide a full line of tires.

When deciding if a product or service should be drop or keep, it is also necessary to


consider the qualitative factors, not just the quantitative. Like in the situation above,
Clayton Herring is thinking, if he should drop the mud and snow tires because it incurred
a loss (which is the quantitative aspect). With that, it is not right to drop the said product
just because it incurred a loss. But, it is also necessary to consider its qualitative factor
that will affect the business in the long-run, which is losing distributors since they
cannot provide a full line of tires.

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