XY Company's product line decision: comparing products W and Z
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XY Company is considering adding a new product line to its current mix, which consists of products X and Y. There are two options that it faces, Product W. And Product Z. The purpose of this report is to examine these two alternatives in order to try and understand which of these products is a better addition to the product mix. There are a number of variables that come into play. While both products appear to be profitable, the impact of this decision on the company as a whole needs to be taken into consideration.
Product W.
The addition of Product W. To the company's product lines results in a variable cost income statement as follows:
Product X
Product Y
Product W
Total
Sales
$275,000
$400,000
$110,000
$785,000
Less variable expenses
Production
100,000
200,000
55,000
$355,000
Selling and administrative
20,000
60,000
11,000
$91,000
Contribution margin
$155,000
$140,000
$44,000
$339,000
Less direct fixed expenses
10,000
55,000
10,000
$75,000
Segment margin
$145,000
$85,000
$34,000
$264,000
Less common fixed expenses
75,000
Net income
$189,000
Prior to adding Product W, the company was earning a net income of $155,000. Thus, adding the new product adds $34,000 to the company's bottom line.
Product Z
The other alternative is Product Z. The projected sales for Product Z. are significantly higher than the projected sales for Product W. However, the costs are higher as well. The following is the variable cost income statement for Product Z:
Product X
Product Y
Product Z
Total
Sales
$275,000
$400,000
$180,000
$855,000
Less variable expenses
Production
100,000
200,000
126,000
$426,000
Selling and administrative
20,000
60,000
9,000
$89,000
Contribution margin
$155,000
$140,000
$45,000
$340,000
Less direct fixed expenses
10,000
55,000
12,500
$77,500
Segment margin
$145,000
$85,000
$32,500
$262,500
Less common fixed expenses
75,000
Net income
$187,500
As noted, the combined income for the company with Product Z. is $187,500. This is slightly lower than the combined income for XY company if it adopts Product W. Based on this analysis, Product W. is the better of the two options, since they are mutually exclusive.
Dropping a Product
There is another option as well, which is to drop one of the existing products. Based on the segment margin for each product, this would not be recommended, at least if the above tables are computed on the basis of an even one-third split for each product. The following table shows the segment margin for each product:
Product X
$145,000
Product Y
$85,000
Product W
$34,000
Product Z
$32,500
All things being equal, it is necessary for the company to take the three best of these, if it can only take three. Thus, the company would not drop either Product X or Product Y. To illustrate, the net income if Product X was dropped would be:
Product W
Product Y
Product Z
Total
Sales
$110,000
$400,000
$180,000
$690,000
Less variable expenses
Production
55,000
200,000
126,000
$381,000
Selling and administrative
11,000
60,000
9,000
$80,000
Contribution margin
$44,000
$140,000
$45,000
$229,000
Less direct fixed expenses
10,000
55,000
12,500
$77,500
Segment margin
$34,000
$85,000
$32,500
$151,500
Less common fixed expenses
75,000
Net income
$76,500
And if Product Y was dropped, it would be:
Product X
Product W
Product Z
Total
Sales
$275,000
$110,000
$180,000
$565,000
Less variable expenses
Production
100,000
$55,000
$126,000
$281,000
Selling and administrative
20,000
$11,000
$9,000
$40,000
Contribution margin
$155,000
$44,000
$45,000
$244,000
Less direct fixed expenses
10,000
$10,000
$12,500
$32,500
Segment margin
$145,000
$34,000
$32,500
$211,500
Less common fixed expenses
75,000
Net income
$136,500
Thus, we can see that the optimal level of net income is $189,000, and that comes from having Product X, Product Y and Product W. As the three-product product mix.
Profitability
The net margins for each product are as follows:
X
52.73%
Y
21.25%
W
30.91%
Z
18.06%
This confirms our earlier findings. Product X is the most profitable in the company, and Product Z. would be the least profitable, on a segment margin basis. If there was no constraint on demand, I would choose Product X solely as a means of maximizing profitability at this company. It has by far the highest segment margin of any product, and therefore would deliver the highest profit for the company is that was the product to be pursued.
Conclusion
Based on this analysis, it is evident that the most profitable products are the two current products, X and Y. If there is excess capacity, then the most profitable product of the two new options should be undertaken, and that is Product W. Product Z. is less profitable than X, Y, or W, and should not be undertaken, given the current constraint that the factory can only produce three products.
References accountingexplanation.com. (n.d.). Advantages, Disadvantages, and Limitations of Variable Costing Systems. From http://www.accountingexplanation.com/advantages_disadvantages_limitations_of_variable_costing.htm
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