Buttercrumbs Bakery expects to sell 1 million scones next year for $1.25 each.The variable cost of a scone is $0.75.Fixed costs are $150,000, depreciation $200,000 and the tax rate is 25%.If the bakery can increase the price of a scone to $1.50 and all other variables remain the same, free cash flow will increase by [blank].
A)$37,500
B)$150,000
C)$187,500
D)$250,000

Question

Quizplus · Accepted Answer

First, let's calculate the current free cash flow:

Revenue = 1 million scones x $1.25 = $1,250,000
Variable costs = 1 million scones x $0.75 = $750,000
Contribution margin = $1,250,000 - $750,000 = $500,000
Fixed costs = $150,000 + $200,000 = $350,000
Earnings before interest and taxes (EBIT) = $500,000 - $350,000 = $150,000
Taxes = $150,000 x 0.25 = $37,500
Net income = $150,000 - $37,500 = $112,500
Free cash flow = $112,500 + $200,000 (depreciation) = $312,500

Now, let's calculate the new free cash flow if the price of a scone is increased to $1.50:

Revenue = 1 million scones x $1.50 = $1,500,000
Variable costs = same as before = $750,000
Contribution margin = $1,500,000 - $750,000 = $750,000
Fixed costs = same as before = $350,000
EBIT = $750,000 - $350,000 = $400,000
Taxes = $400,000 x 0.25 = $100,000
Net income = $400,000 - $100,000 = $300,000
Free cash flow = $300,000 + $200,000 (depreciation) = $500,000

The increase in free cash flow is:
$500,000 - $312,500 = $187,500

Therefore, the correct choice is C, $187,500.

Buttercrumbs Bakery Expects to Sell 1 Million Scones Next Year