Westfall Watches has two product lines: Luxury watches and Sporty watches. Income statement data for the most recent year follow: Total Luxury Sporty Sales revenue $530,000 $400,000 $130,000 Variable expenses 375,000 255,000 120,000 Contribution margin 155,000 145,000 10,000 Fixed expenses 80,000 40,000 40,000 Operating income (loss) $75,000 $105,000 $ (30,000) Assuming the Sporty line is discontinued, total fixed costs remain unchanged, and the space formerly used to produce the Sporty line is used to increase the production of Luxury watches by 250%, how will operating income be affected?

Net income will be $352,500 more if the company continues with Luxury watches only.

Explanation:

Since the company discontinues Sporty watches operation, the company's variable cost is decreasing. However, the fixed expenses remain same as the company will use the space for producing Luxury watches. The effect of operating income will be as follows:

Westfall Watch

Income Statement (Contribution Margin approach)

Particulars $

Sales Revenue [$400,000 + (400,000 x 250%) ] 1,400,000

Less: Variable expenses

[$255,000 + ($255,000 x 250%) ] (892,500)

Contribution Margin 507,500

Less: Fixed Cost (80,000)

Net Income 427,500

Therefore, the net income will be $427,500 which is $ (427,500 - 75,000) = $352,500 more.