KEEP OR DROP FOR SERVICE FIRM, COMPLEMENTARY EFFECTS, FUNCTIONAL BASED ANALYSIS
Serene Assurance Company provides both automobile and life insurance. The projected income statements for the two products are as follows:
|
|
Automobile |
Life |
|
|
Insurance |
Insurance |
|
Sales |
$4,200,000 |
$12,000,000 |
|
Less: Variable expenses |
3,830,000 |
9,600,000 |
|
Contribution margin |
$ 370,000 |
$ 2,400,000 |
|
Less: Direct fixed expenses |
400,000 |
500,000 |
|
Segment margin |
$ (30,000) |
$ 1,900,000 |
|
Less: Common fixed expenses (allocated) |
100,000 |
200,000 |
|
Operating income (loss) |
$ (130,000) |
$ 1,700,000 |
The president of the company is considering dropping the automobile insurance. However, some policyholders prefer having their auto and life insurance with the same company, so if automobile insurance is dropped, sales of life insurance will drop by 15 percent. No significant non unit level activity costs are incurred.
Required:
1. If Serene Assurance Company drops automobile insurance, by how much will income increase or decrease? Provide supporting computations.
2. Assume that increasing the advertising budget by $50,000 will increase sales of automobile insurance by 10 percent and life insurance by 3 percent. Prepare a segmented income statement that reflects the effect of increased advertising. Should advertising be increased?