Closing down divisions

Ainsley Corporation has four operating divisions. The budgeted revenues and expenses for each division for 2014 follows:

Further analysis of costs reveals the following percentages of variable costs in each division:

Closing down any division would result in savings of 40% of the fixed costs of that division.
Top management is very concerned about the unprofitable divisions (A and B) and is considering closing them for the year.

Required:
1. Calculate the increase or decrease in operating income if Ainsley closes division A.
2. Calculate the increase or decrease in operating income if Ainsley closes division B.
3. What other factors should the top management of Ainsley consider before making a decision?

1. and 2.
Division A Division B
Sales $504,000 $948,000
Variable costs of goods sold
($440,000 0.90; $930,000 0.80)
396,000 744,000
Variable S,G & A
($96,000 0.50; $202,500 0.50)
48,000 101,250
Total variable costs 444,000 845,250
Contribution margin $ 60,000 $102,750

Division A Division B
Fixed costs of goods sold
($440,000 ´ 0.10; $930,000 ´ 0.20) $ 44,000 $186,000
Fixed S,G & A
($96,000 ´ 0.50; $202,500 ´ 0.50) 48,000 101,250
Total fixed costs $ 92,000 $287,250
Fixed costs savings if shutdown
($92,000 0.40; $287,250 0.40)
$ 36,800 $114,900

Division A's contribution margin of $60,000 more than covers its avoidable fixed costs of $36,800. The difference of $23,200 helps cover the company's unavoidable fixed costs. Because $36,800 of Division A's fixed costs are avoidable, the remaining $55,200 is unavoidable and will be incurred regardless of whether Division A continues to operate. Division A's $32,000 loss is the rest of the unavoidable fixed costs ($55,200 – $23,200). If Division A is closed, the remaining divisions will need to generate sufficient profits to cover the entire $55,200 unavoidable fixed cost. Consequently, Division A should not be closed because it helps defray $23,200 of this cost.

Division B earns a positive contribution margin of $102,750. Division B also generates $114,900 of avoidable fixed costs. Based strictly on financial considerations, Division B should be closed because the company will save $12,150 ($114,900 –$102,750). Division B is currently incurring $114,900 in fixed costs that it could have avoided while earning only $102,750 in contribution margin.

An alternative set of calculations is as follows:
Division A Division B
Total variable costs $444,000 $845,250
Avoidable fixed costs if shutdown 36,800 114,900
Total cost savings if shutdown 480,800 960,150
Loss of revenues if shutdown (504,000) (948,000)
Cost savings minus loss of revenues $ (23,200) $ 12,150

Division A should not be shut down because loss of revenues if Division A is shut down exceeds cost savings by $23,200. Division B should be shut down because cost savings from shutting down Division B exceeds loss of revenues by $12,150.

3. Before deciding to close Division B, management should consider the role that the Division's product line plays relative to other product lines. For instance, if the product manufactured by Division B attracts customers to the company, then dropping Division B may have a detrimental effect on the revenues of the remaining divisions. Management may also want to consider the impact on the morale of the remaining employees if Division B is closed. Talented employees may become fearful of losing their jobs and seek employment elsewhere.