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CMA Final · Strategic Cost Management · Decisions involving Alternative Choices

Rao Pharma is considering shutting a product line with sales Rs 8,00,000, variable costs Rs 5,00,000 and allocated fixed costs Rs 4,00,000, of which Rs 1,00,000 would be saved on closure. What is the effect of closure on overall profit?

Closing the line reduces overall profit by Rs 2,00,000. The line contributes Rs 3,00,000 over variable costs, but closure saves only Rs 1,00,000 of fixed costs. Unavoidable allocated fixed costs continue and are irrelevant to the decision.

  1. AProfit falls by Rs 2,00,000Correct
  2. BProfit rises by Rs 1,00,000
  3. CProfit rises by Rs 2,00,000
  4. DProfit falls by Rs 1,00,000

Explanation

Contribution lost = 8,00,000 - 5,00,000 = Rs 3,00,000. Fixed costs saved = Rs 1,00,000. Net effect = a fall in profit of Rs 2,00,000. Looking only at the apparent Rs 1,00,000 loss on the line ignores that unavoidable fixed costs remain.

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