Devern Assurance Company provides both property and automobile insurance. The projected income statements for the two products are as follows: Property Insurance Automobile 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 property insurance. However, some policyholders prefer having their property and automobile insurance with the same company, so if property insurance is dropped, sales of automobile insurance will drop by 12 percent. No significant non-unit-level activity costs are incurred.

1. As a supporting computation, prepare a segmented income statement for the keep-or-drop decision.

2.Assume that dropping all advertising for the property insurance line and increasing the corporate advertising budget by $450,000 will increase sales of property insurance by 10 percent and automobile insurance by 8 percent. Prepare a segmented income statement that reflects the effect of increased advertising.

Explanation:

Severn Assurance company.

Decision to drop the Assurance division will result in the below group financials:

Property division:

Sales 10,560,000

Variable expense 8,448,000

Contribution Margin 2,112,000

Direct Fixed Expense 500,000

Segment Margin 1,612,000

Common fixed expense 300,000

Operating income $1,312,000

Prior to the decision to stop the property division, ney income for the group was $1,570,000

This decision leads to decrease in operating income I consider it not acceptable.

Decision: keep property insurance division.

B.

Decision to drop all Property advertising costs of $400,000

And take group advertising spend up by $450,000

Expected to see a growth in sales of property by 10% and automobile by 8%.

Property insurance division Income statement

Sales $4,620,000

Variable costs 4,213,000

Contribution Margin 407,000

Direct fixed expense 0

Segment Margin 407,000

Common fixed expense 250,000

Operating income $157,000

Automobile insurance division Income statement

Sales $12,960,000

Variable costs 10,368,000

Contribution Margin 2,592,000

Direct fixed expense 500,000

Segment Margin 2,092,000

Common fixed expense 500,000

Operating income $1,592,000

Total business net income = $1,749,000

Which is an increase of $179,000 over the original Net income projections.

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