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  • 1.  ppc

    Posted 06-05-2020 08:46 PM

    Pregnancy Pillows Co. (PPC) has provided the following operating profit & loss report for their U.S. Region:

    U.S. Region - Profit & Loss Report (for Pregnancy Pillows Co.)

    (in millions)

    West

    Central

    East

    Total

    Revenue

    $200

    $150

    $150

    $500

    Variable COGS

    (35)

    (30)

    (15)

    (80)

    Variable S&A costs

    (45)

    (30)

    (35)

    (110)

    Contribution margin

    $120

    $90

    $100

    $310

    Fixed COGS

    (50)

    (90)

    (70)

    (210)

    Fixed S&A costs

    (20)

    (40)

    (20)

    (80)

    Allocated corporate costs

    (20)

    (15)

    (15)

    (50)

    Operating profit (loss)

    $30

    ($55)

    ($5)

    ($30)

    Allocation percent

    40.0%

    30.0%

    30.0%

    100.0%

    (based on revenue)

    70% of the fixed COGS and S&A in all operations is avoidable if the operation is shut down.

    Based on the provided information, which, if any, operations should PPC shut down in order to increase total profit?

    PPC should shut down all the operations.

    PPC should shut down the Central operation.

    PPC should shut down the Central and East operations.

    PPC should not shut down any of the operations.


    ------------------------------
    Hend Abdel-Gafar
    Accountant
    Cairo
    Egypt
    ------------------------------


  • 2.  RE: ppc

    Posted 06-06-2020 03:31 AM
    Central operations should be shut down.

    The controllable fixed costs (avoidable fixed costs - 70%) of Central operations is 91M, whereas the contribution from here is 90M. So logically the operations aren't able to cover their controllable Fixed costs itself.

    While this is my assumption. Will like to know whether I was correct..

    Regards,
    Abdul Naser

    ------------------------------
    Abdul Naser Parkar
    Analyst
    Al Nasr, Al Sadd Doha
    Qatar
    ------------------------------

    Original Message


  • 3.  RE: ppc

    Posted 06-06-2020 02:42 PM
    Dear  Hend Abdel-Gafar

    I have worked out the below solution as far as I understand the concept and I am happy to stand corrected, if there are mistakes

    Conclusion: The Western Operations breaks-even after common cost is allocated to 100% while shedding off the operations  of Central and Eastern regions which are proving to be economically not viable.  However from the overall organisation point of view (of performance and profitability) PPC should shut down all the operations operations

    Option 1. Drop Central Operations Only
    Drop Central  Operations only
    (in millions) West Central East Total
    Revenue $200   $150 $350
    Variable COGS -35   -15 ($50)
    Variable S&A costs -45   -35 ($80)
    Contribution margin $120 $0 $100 $220
    Fixed COGS -50 -27 -70 -147
    Fixed S&A costs -20 -12 -20 -52
    Allocated corporate costs -25   -25 -50
             
    Total FC -95 -39 -115 -249
    Operating profit (loss) $25 ($39) ($15) ($29)
    Allocation percent 57.14%   42.86% 100.00%

    Still in the above case the overall performance is in the negative because of the allocated costs and Fixed costs not fully vanishing from the picture (30%  (FC X (1-70%) relevant costs still lingering, that pulls down the overall contribution margin)

    Option 2
    Drop Central and East Operations
    (in millions) West Central East Total
    Revenue $200     $200
    Variable COGS -35     ($35)
    Variable S&A costs -45     ($45)
    Contribution margin $120 $0 $0 $120
    Fixed COGS -50 -27 -21 -98
    Fixed S&A costs -20 -12 -6 -38
    Allocated corporate costs -50     -50
             
    Total FC -120 -39 -27 -186
    Operating profit (loss) $0 ($39) ($5) ($66)
    Allocation percent 100.00%     100.00%

    In a ADD<> KEEP<>DROP a segment decision, one should look for words like "Allocated' , 'Avoidable' to spot the relevant or irrelevant fixed costs.
    Once the contribution margin and avoidable fixed cost is identified, the decision to add/keep/drop can be made with a good assurance
    If the avoidable fixed costs saved are greater than the contribution margin for a segment of busiess or operations, it is always better to eliminate that segment so that the 'pulling down' effect of that segment on other profitable areas is also eliminated from the overall profitability point of view.

    PS: As I started in the prelude of this solution, please come back to me for any material deviation or error in my approach so that our knowledge is enriched further.

    Kind regards
    Srirama Nagarajan



    Original Message


  • 4.  RE: ppc

    Posted 06-07-2020 06:12 AM
      |   view attached
    Hello Hend,

    Hope you are safe & doing well in CMA study

    In this case study we should focus on the following points:
    • Incremental revenue vs incremental cost 
    • Irrelevant costs (Sunk or unavoidable) 30% of fixed COGS and 30% of S&A costs, plus 100% of corporate cost
    • Applicable options (Given answers)

    Option (1): Shut down all the operations >>> Total increased loss = ($107) Million
    Very obvious, because no more Contribution Margin, while fixed costs are still exist by 30% of COGS + G&A and 100% of corporate costs (Irrelevant)
    OI = Total CM - 30% x (Fixed COGS + G&A) - Fixed corporate costs = 0 - 0.30 x (210 + 80) - 50 = ($137)

    Option (1): Shut down all the operations


    Option (2): Shut down the Central operation >>> Total reduced loss = $1 Million    (Correct answer)
    Incremental result of Central operation = 0 - 0.3 x (90 + 40) - 15 = ($54)  >>>  Notice that, loss has decreased by $1 Million >>> Incremental Profit

    Option (2): Shut down the Central operation


    Option (3): Shut down all the Central & East operation >>> Total increased loss = ($36) Million
    Incremental result = [ 0 - 0.3 x (90 + 40) - 15 ] + [ 0 - 0.3 x (70 + 20) - 15] = ($54) + ($42) = ($96)  >>>  Compared to ($55 + $5) >>> Incremental Loss
    Option (3): Shut down the Central & East operations


    Option (4): Should not shut down any of the operations >>> The main given information to compare with

    Hope this illustration will be helpful to master the Marginal Analysis key concepts:
    • Incremental revenue Vs Incremental cost
    • Relevant Vs Irrelevant costs

    Wish you best of luck, success, safe & healthy condition

    Kind regards

    ------------------------------
    Samer Ahmad, FMVA, SCA
    Kuwait
    ------------------------------

    Attachment(s)

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    Marginal Analysis_Pregnancy Pillows Co..pdf   11 KB 1 version
    Original Message