Eliminating a product line (LO2, LO3, Appendix B). Spring Fresh provides commercial laundry and dry-cleaning services to local hospitals, hotels, and restaurants. Management believes that the dry-cleaning business is a loser, even though dry-cleaning operations yield a high contribution margin. Moreover, based on summary financial data from the most recent year of operations (presented here) management is seriously considering getting out of the dry-cleaning business.

Laundry Dry Cleaning Total

Revenue $3,000,000 $1,000,000 $4,000,000

Variable costs $1,000,000 $200,000 $1,200,000

Contribution margin $2,000,000 $800,000 $2,800,000

Traceable fixed costs $1,000,000 $500,000 $1,500,000

Common fixed costs* $500,000 $500,000 $1,000,000

Profit $500,000 ($200,000) $300,000

*These costs relate to the sales force, reception, and delivery trucks that are common to both lines of business. Management has arbitrarily allocated an equal amount to each line.

a. Assume that common fixed costs would decrease by $200,000 if the dry-cleaning business were closed. By how much will Spring Freshs profit increase or decrease if it closes the dry-cleaning operations?

b. Suppose that closing the dry-cleaning business would increase overall laundry revenue by 10%. Specifically, while some customers would be lost because they value one-stop cleaning convenience, the sales force will be better able to focus its efforts because there will be only one product line. How does this information affect your answer to part (a)? That is, by how much will Spring Freshs profit increase or decrease if it closes the dry-cleaning operations?