world-famous discounter, Fernwood Booksellers, specializes in selling paperbacks for $7 each The variable cost per book is $5 At current annual sales of 200,000 books, the publisher is just breaking even It is estimated that if the authors' royalties are reduced, the variable cost per book will drop by $1 Assume authors' royalties are reduced and sales remain constant; how much more money can the publisher put into advertising (a fixed cost) and still break even?

Question

Quizplus · Accepted Answer

The current contribution margin per book is $2 ($7 selling price - $5 variable cost). If the variable cost per book drops by $1, the new contribution margin per book is $3.

To break even with 200,000 books, the publisher needs to generate $0 in profit. This means that the total contribution margin from selling 200,000 books must equal the total fixed cost, which we'll call "F."

Set up the equation:

$3 contribution margin per book * 200,000 books - $5 variable cost per book * 200,000 books = F fixed costs

Solve for F:

$600,000 - $1,000,000 = F

F = -$400,000

This means that, at current sales levels and with current costs, the publisher is losing $400,000.

If the publisher reduces the variable cost per book by $1, the contribution margin per book increases to $3. The new equation is:

$3 contribution margin per book * 200,000 books - $4 variable cost per book * 200,000 books = F fixed costs

Solve for F:

$600,000 - $800,000 = F

F = -$200,000

This means that, with the reduced variable costs, the publisher is now losing $200,000.

To break even again, the total contribution margin from selling 200,000 books must equal the total fixed cost:

$3 contribution margin per book * 200,000 books = F fixed costs

F = $600,000

This means that the maximum amount the publisher can put into advertising (a fixed cost) and still break even is $600,000. Any more than that, and the publisher would be losing money.

Therefore, the best choice is D, $200,000.

World-Famous Discounter, Fernwood Booksellers, Specializes in Selling Paperbacks for $7