Reference no: EM132947854
Question - KM Inc. has four segments namely - Krang, Kreng, Kring and Krung. Data on sales and expenses for the immediately preceding year are as follows: (See table below)
Management is concerned about the continued losses shown by Kreng and Krung and ask you for a recommendation. Salaries of product line managers could be eliminated if the respective unprofitable product line is discontinued. The equipment used to produce each product can still be used for other purposes.
After careful evaluation, you provided the following options for the management to decide:
To discontinue the unprofitable product line and use its current equipment to produce Krang which will result to an increase in its sales by 25%.
To invest in improving equipment used in the production of the unprofitable product line to reduce its variable cost by 45%. The cost of equipment is P12,000, which will be depreciated on a straight-line basis for 3 years. The cost of capital is 8%.
To cease the production of the unprofitable product line but instead purchase its entire product requirement from Kring, which is currently operating at excess capacity. Kring, however, will need to incur additional P6.00 per unit to adjust its products to the design set by the unprofitable product-line. The managers agreed at a price equal to 150% of the total relevant costs incurred by Kring. The unused equipment will then be used to produce Krung, which will result to an increase in its sales by 3%. Further, 90% of the existing variable costs of the unprofitable product line will be eliminated.
A. Assuming the management chooses to discontinue the unprofitable product line, what is the net impact to the Company's overall profit?
B. Assuming the management chooses the second option, what is the net impact to the Company's annual profit?
C. Assuming the management chooses the third option, what is the transfer price that Kring should charge to the unprofitable product line?
D. Which among the options would be beneficial for the Company?