Playpal Ltd Considering Dropping Its Doomdrum Toy

Playpal Ltd Is Considering Dropping Its Doomdrum Toy Due To The Conti

PlayPal Ltd. is considering discontinuing its DoomDrum toy due to ongoing financial losses. The company has provided data on sales and expenses for the past year: sales of 15,000 units, total revenue of £150,000, variable expenses of £120,000, contribution margin of £30,000, fixed expenses of £40,000, and a net operating loss of (£10,000). If the toy is discontinued, PlayPal Ltd. could avoid £8,000 of fixed costs annually. The assignment involves analyzing the financial impact of discontinuing the toy, determining break-even sales levels, considering the effects of increased sales of other toys, and evaluating pricing and qualitative factors influencing the decision.

Paper For Above instruction

Introduction

The decision for PlayPal Ltd. to discontinue its DoomDrum toy involves a comprehensive analysis of cost behavior, contribution margins, and strategic implications. While the toy currently results in an operating loss, understanding the detailed financial components enables management to make an informed decision that balances economic and qualitative factors. This paper discusses the calculation of the change in operating income from discontinuation, identifies the sales level at which the company is indifferent, analyzes the impact of increased sales from other toys, and evaluates pricing considerations alongside qualitative factors affecting the decision-making process.

Financial Analysis of Discontinuation

The data indicates that the DoomDrum toy's current sales of 15,000 units yield revenue of £150,000, with variable expenses totaling £120,000. The resulting contribution margin of £30,000 partially covers fixed expenses of £40,000, resulting in a net operating loss of £10,000.

Requirement A focuses on calculating the financial impact if PlayPal discontinues the toy. If the toy is dropped, the company would save £8,000 of fixed costs but would lose the contribution margin of £30,000 associated with the toy's sales. The net effect on operating income is determined by subtracting the avoided fixed costs from the lost contribution margin:

- Loss of contribution margin = £30,000

- Fixed costs saved = £8,000

- Change in operating income = £8,000 (savings) - £30,000 (lost contribution margin) = -£22,000

Result: Discontinuing the DoomDrum toy would decrease operating income by £22,000, indicating a financial disadvantage even though the toy currently operates at a net loss. This calculation underscores that the contribution margin generated by the toy exceeds the costs that can be eliminated and should be considered when evaluating discontinuation.

Break-Even Sales Level for Indifference

Requirement B involves calculating the sales volume at which PlayPal Ltd. would be indifferent to continuing or discontinuing the product. To find this, set the net benefit of continuing sales equal to zero:

Let \(x\) be the number of units needed for breaking even on the contribution margin basis, considering the avoided fixed costs if discontinued. The contribution margin per unit is:

- \( \text{Contribution margin per unit} = \frac{£30,000}{15,000} = £2 \) per unit

Monthly break-even occurs when:

- (Contribution margin per unit) * x = Fixed costs - Fixed costs avoided

- \( £2 \times x = (£40,000 - £8,000) = £32,000 \)

- \( x = \frac{£32,000}{£2} = 16,000 \) units

Result: PlayPal Ltd. would be indifferent at approximately 16,000 units of annual sales. Below this level, discontinuing would be favorable; above this level, continuing is preferred. The analysis reveals that the current sales are below this threshold, indicating that the toy's contribution margin is critical for covering fixed costs.

Commentary: The current sales level of 15,000 units yields a loss, but increasing sales to 16,000 units would cover fixed costs and eliminate the operating loss. This emphasizes the importance of sales volume in manufacturing decisions and suggests that strategies to boost sales could render the product more financially viable.

Impact of Increased Contribution Margin from Other Toys

Requirement C considers the scenario where discontinuing DoomDrum allows other toys’ sales to increase, resulting in an additional contribution margin of £16,000. The net change in operating income is then computed by:

- Loss of contribution margin from DoomDrum = -£30,000

- Fixed costs saved by discontinuation = -£8,000

- Additional contribution from other toys = +£16,000

Net change:

- \( -£30,000 + £8,000 + £16,000 = -£6,000 \)

Result: The net effect of discontinuing DoomDrum, considering increased sales of other toys, would be a decrease in operating income by £6,000. While the additional contribution from other toys partially offsets the loss from discontinuing DoomDrum, the overall financial position still deteriorates slightly.

Implication: This analysis highlights that strategic increases in sales of other products can mitigate some losses from discontinuation, but they may not fully offset the initial contribution margin loss, underscoring the importance of product mix decisions.

Pricing and Qualitative Considerations

Requirement D explores the minimal selling price per unit at which PlayPal Ltd. would be indifferent between continuing or discontinuing the DoomDrum, factoring in the additional contribution from increased sales of other toys.

Using the previous data:

- Total contribution margin needed to break even considering the added contribution from other toys and fixed cost savings:

\( \text{Contribution margin from DoomDrum} = (£40,000 - £8,000) - £16,000 = £16,000 \)

- Contribution margin per unit remains at £2, as previously calculated.

To find the selling price per unit (SP):

- Revenue per unit, \( P \), must generate contribution of £2 per unit:

\( P - \text{Variable expenses per unit} = £2 \)

- From the original data, variable expenses are:

\( \frac{£120,000}{15,000} = £8 \) per unit

- To cover the contribution margin:

\( P - £8 = £2 \)

\( P = £10 \)

Result: The minimal selling price per DoomDrum unit, at which the company remains indifferent, is approximately £10. At this price, total contribution margin from sales equal the fixed costs saved plus the added contribution from other toys.

Qualitative Factors: Pricing decisions are not solely based on numerical break-even points. Brand reputation, customer loyalty, market positioning, and potential for future sales growth are crucial. Additionally, discontinuing a product may impact market perception and the company's product portfolio. Competition and potential for innovation may also influence whether maintaining or dropping the product aligns with long-term strategic goals.

Conclusion

The analysis indicates that, financially, PlayPal Ltd. would experience a significant operating loss by discontinuing the DoomDrum toy, unless sales are increased beyond the current level. The break-even sales point is approximately 16,000 units, and increasing contribution margins from other products offers some mitigation but not full offsetting of losses. Pricing strategies must balance the cost structure, contribution margins, and market factors, with a suggested minimal selling price of about £10 per unit under current assumptions. Qualitative considerations such as brand impact, market positioning, and strategic fit are critical complements to these quantitative analyses, guiding the final decision on whether to discontinue the product.

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