Case - RELEVANT COST

Suppose James Smith is considering discontinuing its organic dried fruit product line. Assume that during the past year, the organic dried fruit's product line income statement showed the following:

Sales revenue                            $ 5,250,000

Less: Cost of goods sold              6,450,000

Gross profit                                (1,200,000)

Less: Operating expenses            1,500,000

Operating income (loss)               (2,700,000)

Fixed manufacturing overhead costs account for 40% of the cost of goods, while only 30% of the operating expenses are fixed. Since the organic dried fruit line is just one of the company's fruit operations, only $775,000 of direct fixed costs (the majority of which is advertising) will be eliminated if the product line is discontinued. The remainder of the fixed costs will still be incurred by the company. If the company decides to discontinue the product line, what will happen to the company's operating income? Should James Smith discontinue product line?